sections 548 and 550 recent developments in the law … · in the law of fraudulent transfers and...

SECTIONS 548 AND 550—RECENT DEVELOPMENTSIN THE LAW OF FRAUDULENT TRANSFERS ANDRECOVERIES

Maryann Gallagher*

I. INTRODUCTION

Fraudulent transfer avoidance and recovery are principallygoverned by two independent sections of the Bankruptcy Code,1

sections 548 and 550, respectively. This article �rst provides anintroductory discussion of these provisions,2 and then discussescertain of the cases decided in 2011 that clari�ed or otherwiserelied on these or similar provisions.

Similar to recent years, as bankruptcy cases �led in the wakeof the disruption to the �nancial markets commencing in 2007moved toward their conclusions, litigation of avoidance actionsensued, causing 2011 to be another robust year for fraudulenttransfer decisions under the Bankruptcy Code. Signi�cantly, inone of three pending appeals from the bankruptcy court's deci-sion (a) avoiding over $500 million in liens and upstreamguarantees granted by the subsidiaries of TOUSA, Inc. to securea prepetition �nancing transaction and (b) ordering the disgorge-ment of proceeds, the United States District Court for theSouthern District of Florida reversed and quashed the portion ofthe bankruptcy court's decision �nding lack of reasonably equiva-lent value for the liens granted by subsidiaries and related

*Maryann Gallagher is counsel to the law �rm Curtis, Mallet-Prevost, Colt& Mosle LLP (“Curtis”). Ms. Gallagher gratefully acknowledges Heather Eliza-beth Saydah and James Zimmer, associates at Curtis who assisted Ms. Gal-lagher with this article, and the Hon. Timothy A. Barnes, a former partner atCurtis who authored this article from 1999 through 2008. The opinionsexpressed are not necessarily the opinions of Curtis or its Restructuring andInsolvency Group. Nothing contained in this article should be construed as suchor as legal advice or legal positions.

1Pub. L. No. 95-598, 92 Stat. 2549 (1978) (codi�ed as amended at 11 U.S.C.

§§ 101 to 1532 (2011) (the “Bankruptcy Code”).2Though this article addresses recent developments in sections 548 and

550, out of necessity it also brie�y discusses section 544, and other major bank-ruptcy provisions addressing fraudulent conveyances, including section 546, aBankruptcy Code section that places certain limits on a trustee's or debtor-in-possession's avoidance powers. See 11 U.S.C. §§ 544 and 546.

1025

transactions, and requiring the disgorgement of proceeds.3 Onthe eve of publication of this article, however, the United StatesCourt of Appeals for the Eleventh Circuit Court of Appeals re-versed the district court's decision and a�rmed the bankruptcycourt's controversial decision.4 Other decisions of note from 2011resolve disputes about the applicable standards for the good faithdefenses under sections 548(c) and 550(b) of the BankruptcyCode,5 the requirements for reliance on the “mere conduit” excep-tion to liability under section 550(a) of the Bankruptcy Code,6

and the related issue of determining who can be an “initialtransferee” for purposes of section 550(a) of the BankruptcyCode.7 Ponzi scheme cases were once again the source of deci-sions addressing the issues of reasonably equivalent value, thestandards for examining the “good faith” defense of section 548(c)of the Bankruptcy Code, and the applicability of the safe harbor

3In re TOUSA, Inc., 422 B.R. 783 (Bankr. S.D. Fla. 2009). TOUSA I was

discussed at length in the 2010 edition of this article. See Lara R. Sheikh,Section 548 and 550—Developments in the Law on Fraudulent Transfers andRecoveries, Norton Annual Survey of Bankruptcy Law 295 (2010 ed.). Brie�y, inTOUSA II, the United States District Court for the Southern District of Florida,(citing the 2010 edition of this article), held that (i) settlement payments to theTranseastern Lenders (de�ned herein) were not fraudulent transfers because(A) the settlement proceeds were not property of the subsidiaries and (B) even ifthe proceeds were property of the subsidiaries, the subsidiaries received reason-ably equivalent value in exchange for granting liens on their assets and (ii)even if the transaction was a fraudulent transfer, the Transeastern Lenderswere not entities from whom a fraudulent transfer could be recovered undersection 550 of the Bankruptcy Code. Importantly, the decision in TOUSA I,which was recently a�rmed by the Eleventh Circuit Court of Appeals,contributed to actions seeking to limit recoveries to prepetition secured lendersbased, in part, upon such lenders' troublesome practices, including an over-reliance on subsidiary guaranties. See, e.g., In re Schaefer, 2009 WL 3367389,*2–3 (Bankr. S.D. Ill. 2009) (bankruptcy court adopted reasoning similar toTOUSA I to invalidate a mortgage granted by the debtor principals of a non-debtor corporation to secure a note of the non-debtor corporation).

4See In re TOUSA, Inc., 680 F.3d 1298, 56 Bankr. Ct. Dec. (CRR) 135

(11th Cir. 2012) (“TOUSA III”).5See, e.g., In re Nieves, 648 F.3d 232, 65 Collier Bankr. Cas. 2d (MB) 1442,

Bankr. L. Rep. (CCH) P 82024 (4th Cir. 2011).6See, e.g., In re Harwell, 628 F.3d 1312, 54 Bankr. Ct. Dec. (CRR) 12, 64

Collier Bankr. Cas. 2d (MB) 1820, Bankr. L. Rep. (CCH) P 81909 (11th Cir.2010); In re Brooke Corp., 458 B.R. 579, 55 Bankr. Ct. Dec. (CRR) 154 (Bankr.D. Kan. 2011); In re Lambertson Truex, LLC, 458 B.R. 155, 55 Bankr. Ct. Dec.(CRR) 148 (Bankr. D. Del. 2011); In re Bower, 462 B.R. 347, Bankr. L. Rep.(CCH) P 82143 (Bankr. D. Mass. 2012).

7In re Harwell, 628 F.3d 1312, 54 Bankr. Ct. Dec. (CRR) 12, 64 Collier

Bankr. Cas. 2d (MB) 1820, Bankr. L. Rep. (CCH) P 81909 (11th Cir. 2010).

Norton Annual Survey of Bankruptcy Law, 2012 Edition

1026

from avoidance included in section 546 of the Bankruptcy Code.8

These and other important 2011 fraudulent transfer decisionsare addressed in section III below.

II. BACKGROUNDEnacted as part of the original 1978 Bankruptcy Reform Act,

sections 548 and 550 of the Bankruptcy Code were largelyunchanged in their �rst twenty years. However, section 548,which sets forth a trustee's or debtor-in-possession's power toavoid certain prepetition fraudulent transfers and obligations,underwent signi�cant changes in 1998 in its structure as a resultof the enactment of the Religious Liberty and Charitable Dona-tion Protection Act of 1998 (the “Charitable Donation Act”),9 andagain in 2005 as a result of the enactment of the BankruptcyAbuse Prevention and Consumer Protection Act of 2005(“BAPCPA”).10

As further discussed below, section 550, which sets forth thetrustee's or debtor-in-possession's power to recover the value ofavoided transfers, also was signi�cantly amended under theBankruptcy Amendments and Federal Judgeship Act of 1984 (the“1984 Amendments”),11 the Bankruptcy Reform Act of 1994 (the“1994 Reform Act”)12 and BAPCPA.

8See, e.g., Perkins v. Haines, 661 F.3d 623, 55 Bankr. Ct. Dec. (CRR) 166,

Bankr. L. Rep. (CCH) P 82094 (11th Cir. 2011); Picard v. Katz, 462 B.R. 447, 55Bankr. Ct. Dec. (CRR) 133, Bankr. L. Rep. (CCH) P 82077 (S.D. N.Y. 2011),motion to certify appeal denied, 466 B.R. 208, 55 Bankr. Ct. Dec. (CRR) 266(S.D. N.Y. 2012); In re Bernard L. Mado� Inv. Securities LLC;, 2011 WL3897970 (S.D. N.Y. 2011); In re Dreier LLP, 452 B.R. 391 (Bankr. S.D. N.Y.2011).

9Pub. L. No. 105-183, 112 Stat. 517 (1998), codi�ed at 11 U.S.C. § 548(a)(2).

For an in-depth discussion of the Charitable Donation Act, see Hiren Patel,Section 548—Recent Developments in the Law of Fraudulent Transfers, NortonAnnual Survey of Bankruptcy Law at 527 (1998 ed.).

10Pub. L. No. 109-8 (2005). BAPCPA was signed into law on April 20, 2005.

While BAPCPA was largely e�ective on October 17, 2005, BAPCPA §§ 1501(a)and 1406(a) were e�ective only with respect to cases commenced on or afterthat date. Changes made to § 548 and BAPCPA § 1501(b)(1) were generally ef-fective immediately.

11Pub. L. No. 98-353, 98 Stat. 333 (1984).

12Pub. L. No. 103-394, 108 Stat. 4106, 4121 (1994) (an attempt to expressly

overrule the Seventh Circuit's decision in Levit v. Ingersoll Rand FinancialCorp., 874 F.2d 1186, 19 Bankr. Ct. Dec. (CRR) 574, 22 Collier Bankr. Cas. 2d(MB) 36, 11 Employee Bene�ts Cas. (BNA) 1323, Bankr. L. Rep. (CCH) P 72910(7th Cir. 1989)).

Sections 548 and 550—Recent Developments in the Law of FraudulentTransfers and Recoveries

1027

A. History and Construction of Section 548Section 548 is derived in large part from section 67(d) of the

Bankruptcy Act of 1898.13 Section 67(d) was codi�ed at section107(d) of old Title 11, prior to the enactment of the BankruptcyCode. Its history dates from the Statute of Elizabeth (13 Eliz. c. 5(1570)). Section 548 consists of four major subsections that setforth the trustee's (or debtor-in-possession's) general powers foravoiding transfers made with the intent to hinder, delay ordefraud creditors (“actually fraudulent” transfers) or made whilethe debtor was insolvent and not in exchange for reasonablyequivalent value (“constructively fraudulent” transfers) undersection 548(a)(1)14 as follows:

The trustee may avoid any transfer (including any transfer to or forthe bene�t of an insider under an employment contract) of an inter-est of the debtor in property, or any obligation (including any obliga-tion to or for the bene�t of an insider under an employmentcontract) incurred by the debtor, that was made or incurred on orwithin 2 years before the date of the �ling of the petition, if thedebtor voluntarily or involuntarily:

(A) made such transfer or incurred such obligation with actualintent to hinder, delay, or defraud any entity to which the debtorwas or became, on or after the date that such transfer was madeor such obligation was incurred, indebted; or

(B) (i) received less than a reasonably equivalent value inexchange for such transfer or obligation; and

(ii) (I) was insolvent on the date that such transfer was madeor such obligation was incurred, or became insolvent as a resultof such transfer or obligation;15

(II) was engaged in business or a transaction, or was about

1330 Stat. 544 (July 1, 1898) (as amended and as subsequently repealed by

the Bankruptcy Code, the “Bankruptcy Act”); see S. Rep. No. 989, 95th Cong.,2nd Sess. (1978), as reprinted in 1978 U.S.C.C.A.N. 5787.

14Due to the renumbering of section 548 that took place with the incorpora-

tion of the Charitable Donation Act, care should be taken when researchingearlier cases. For example, the “reasonably equivalent value” provision in thepresent section 548(a)(1)(B)(i) was contained in section 548(a)(2)(A) prior to therevisions.

15The question as to who bears the burden of solvency versus insolvency

has been addressed by one court under unusual circumstances. In Eerie World,a defendant moved for summary judgment on this issue in a trial that lasted foryears. Eerie World Entertainment, L.L.C. v. Bergrin, 2004 WL 2712197, *2–3(S.D. N.Y. 2004). The plainti�'s response was to rest on the allegations in thepleadings, arguing that solvency was a question of fact, not law. The court inEerie World found that while solvency was a question of fact ordinarily reservedfor a jury, as a response to a summary judgment motion in such a case, restingon the pleadings was entirely inappropriate and warranted judgment in thedefendant's favor; see also In re Worldcom, Inc., 357 B.R. 223, 230 (S.D. N.Y.


1028

to engage in business or a transaction, for which any prop-erty remaining with the debtor was an unreasonably smallcapital;

(III) intended to incur, or believed that the debtor wouldincur, debts that would be beyond the debtor's ability to payas such debts matured; or

(IV) made such transfer to or for the bene�t of an insider,or incurred such obligation to or for the bene�t of an insider,under an employment contract and not in the ordinary courseof business.

The prefatory paragraph of section 548(a)(1) generally getsmuch less attention by the courts than the subtest provisions ofsection 548(a)(1)(A) and (B). BAPCPA, however, made twochanges to the prefatory paragraph.16

The �rst change relates to changes discussed below with re-spect to employment contracts as a fourth subtest for reasonablyequivalent exchange. As “transfer” is already broadly de�ned inthe Bankruptcy Code,17 the addition of “including any transfer toor for the bene�t of an insider under an employment contract” af-ter the word “transfer” in section 548(a)(1) arguably does nothing

2006) (grant of debtors' summary judgment motion upheld where evidence ofinsolvency was so great that insolvency was decided as a matter of law).

16In addition to direct changes, BAPCPA also changed other Bankruptcy

and United States Code provisions governing actions under section 548. The�rst such change relates to the venue of avoidance actions. See 28 U.S.C.§ 1409(a). While this section has been referred to by some as the preferencevenue statute, it should apply to fraudulent transfer recovery actions as well.Generally, unless de minimis, all such actions may be brought where the bank-ruptcy case itself is venued. For de minimis actions, however, 28 U.S.C. § 1409(a)dictates that such cases may be brought only in the district in which the defen-dant resides.

BAPCPA also adjusted the thresholds for such de minimis actions. Priorto its enactment, such actions were delineated as ones “to recover a money judg-ment of or property worth less than $1,000 or a consumer debt of less than$5,000.” Post-BAPCPA and after several annual adjustments, the currentthreshold for property or money judgments is $1,175, the threshold for consumerdebts is $17,575 and the threshold, added by BAPCPA, for debts (excludingconsumer debts) against non-insiders is $11,725. Actions seeking to avoidsmaller amounts as fraudulent transfers must be brought in the district wherethe defendant resides. 11 U.S.C. § 1409(b).

1711 U.S.C. § 101(54); see In re Bernard, 96 F.3d 1279, 1282, 36 Collier

Bankr. Cas. 2d (MB) 1585 (9th Cir. 1996) (‘‘ ‘[A] transfer is a disposition of aninterest in property. The de�nition is as broad as possible . . . Under this de�-nition, any transfer of an interest in property is a transfer, including a transferof possession, custody or control even if there is no transfer to title, because pos-session, custody and control are interests in property.’ ”) (quoting S.Rep. No.95-989 (1978)). See generally 2 Collier on Bankruptcy ¶ 101.54 (Alan N. Resnickand Henry J. Sommer eds., 16th ed. 2012).


1029

other than communicate that Congress understands there is aperceived problem in this realm (something that could have beeneasily communicated in the legislative history to BAPCPA).

The second change altered the look-back period in section 548from one to two years.18 Unlike the majority of changes to section548, the change to the look-back period was applicable “only withrespect to cases commenced . . . more than one year after thedate of the enactment of [BAPCPA].”19 The two-year limitation inthis section is augmented by the operation of section 546(a) of theBankruptcy Code20 and section 544(b)(1) of the BankruptcyCode,21 the latter of which allows the trustee to bootstrap into

18See 11 U.S.C. § 548(a)(1), (b).

19BAPCPA § 1406(b)(2). For a case that a�rms the timing element, and

also considers a number of other statute of limitations, relation back and re-lated principles, see In re Circle Y of Yoakum, Texas, 354 B.R. 349, 47 Bankr.Ct. Dec. (CRR) 117 (Bankr. D. Del. 2006). Since BAPCPA was signed into law inApril 20, 2005, the change to the look-back period is applicable to cases com-menced on or after April 20, 2006.

20Section 546(a) provides in relevant part as follows:

(a) An action or proceeding under section 544, 545, 547, 548, or 553 of this titlemay not be commenced after the earlier of—

(1) the later of—(A) 2 years after the entry of the order for relief; or(B) 1 year after the appointment or election of the �rst trustee under section 702,

1104, 1163, 1202, or 1302 of this title if such appointment or such election oc-curs before the expiration of the period speci�ed in subparagraph (A) . . .

11 U.S.C. § 546(a)(1). The United States Court of Appeals for the Eighth Circuitrecently examined the two-year look-back period of section 546(a) and held that“the plain language of § 546(a) provides that a complaint �led on the two-yearanniversary of the entry of the order for relief . . . is not time barred.” See In reRaynor, 617 F.3d 1065, 1071, 53 Bankr. Ct. Dec. (CRR) 144, 63 Collier Bankr.Cas. 2d (MB) 1765, Bankr. L. Rep. (CCH) P 81836 (8th Cir. 2010), cert. denied,131 S. Ct. 945, 178 L. Ed. 2d 756 (2011).

21Section 544(b)(1) provides as follows:

Except as provided in paragraph (2), the trustee may avoid any transfer of an interestof the debtor in property or any obligation incurred by the debtor that is voidableunder applicable law by a creditor holding an unsecured claim that is allowableunder section 502 of this title or that is not allowable only under section 502(e) of thistitle.

11 U.S.C. § 544(b)(1). See generally In re Adelphia Recovery Trust, 634 F.3d 678,692 n.6, 54 Bankr. Ct. Dec. (CRR) 89 (2d Cir. 2011); In re Moore, 608 F.3d 253,259–61, 53 Bankr. Ct. Dec. (CRR) 68, Bankr. L. Rep. (CCH) P 81781 (5th Cir.2010). In a 2009 bankruptcy court decision, the court concluded that the federallook-back period under section 548(a)(1)(A) does not preempt the applicablestate fraudulent transfer look-back period. In re Supplement Spot, LLC, 409B.R. 187, 197–99 (Bankr. S.D. Tex. 2009).


1030

state fraudulent conveyance law, which in turn can o�er a look-back period of four or more years.22

The majority of the attention paid by the courts to section548(a) is to the subtests in section 548(a)(1)(A) and section548(a)(1)(B)—the so-called “actual” and “constructive” fraud tests,respectively.23 With respect to the former, several cases discussso-called “badges of fraud” in the context of circumstantial evi-dence of such intent.24

22All but a handful of states have adopted the Uniform Fraudulent

Transfers Act (“UFTA”), which provides that, for fraudulent transfers madewith actual intent, the look-back period is either four years, or one year afterthe transfer or obligation was or could have reasonably been discovered by theclaimant, whichever is greater. See UFTA § 9(a); accord In re Maine Poly, Inc.,317 B.R. 1, 7–12 (Bankr. D. Me. 2004) (the court examined both Maine's UFTAand section 548 of the Bankruptcy Code to determine that the parentcorporation's receipt of debt cancellation as part of an asset sale was a�ectedwith no actual intent to hinder, delay, or defraud creditors). Alaska, Kentucky,Louisiana, Maryland, New York, South Carolina and Virginia have not adoptedthe UFTA. See Legislative Fact Sheet—Fraudulent Transfer Act of the NationalConference of Commissioners on Uniform State Laws, available at http://www.nccusl.org/LegislativeFactSheet.aspx?title=Fraudulent Transfer Act (last visitedon May 7, 2012).

23See In re Hannover Corp., 310 F.3d 796, 799, 40 Bankr. Ct. Dec. (CRR)

116, 49 Collier Bankr. Cas. 2d (MB) 1061, Bankr. L. Rep. (CCH) P 78741 (5thCir. 2002); Frierdich v. Mottaz, 294 F.3d 864, 869–70, 39 Bankr. Ct. Dec. (CRR)210, Bankr. L. Rep. (CCH) P 78674, 47 U.C.C. Rep. Serv. 2d 1451 (7th Cir.2002) (trustee can prove actual intent to defraud by circumstantial evidence,such as whether the debtor retained control of the property after the transfer,whether he had a close relationship with the transferee, whether he receivedconsideration for the transfer and whether he made the transfer before or afterbeing threatened with suit by his creditors); cf. In re Erlewine, 349 F.3d 205,211–13, 42 Bankr. Ct. Dec. (CRR) 12, Bankr. L. Rep. (CCH) P 78938 (5th Cir.2003) (despite description of division of property contained therein as“disproportionate,” court required a showing of actual fraud before failing togive comity to state divorce decree). As discussed in more detail below, thedistinction between the actual and constructive fraud sections becomes adeterminative factor with respect to a number of rights and remedies (e.g., withrespect to the limitations on avoidance contained in §§ 546 and 548(c) of theBankruptcy Code).

24See, e.g., In re Bayou Group, LLC, 439 B.R. 284, 307 (S.D. N.Y. 2010)

(“Bayou IV”) (payments to investors in the fund operated as a Ponzi schemewere accompanied by numerous “badges of fraud” su�cient to imply actualintent to defraud on the part of the fund's principals) (Bayou IV was discussedat length in the 2011 edition of this article). See Maryann Gallagher, Section548 and 550—Developments in the Law on Fraudulent Transfers and Recover-ies, Norton Annual Survey of Bankruptcy Law 1119 (2011 ed.); see also AdelphiaRecovery Trust v. Bank of America, N.A., 624 F. Supp. 2d 292, 334–35 (S.D.N.Y. 2009) (margin lenders had reason to believe Adelphia was insolvent but


1031

Additionally, there are numerous cases discussing what does ordoes not constitute “reasonably equivalent value” under section548(a)(1)(B)(i) and the standards or proof for establishing suchvalue.25

continued to accept loan payments in order to keep margin lending facilitiesopen, thus prolonging fraud); In re Frierdich, 294 F.3d at 870, supra, note 23;ASARCO LLC v. Americas Mining Corp., 396 B.R. 278 (S.D. Tex. 2008) (courtfound actual intent to hinder, delay and defraud creditors by a preponderanceof the evidence after examining “badges of fraud” and other circumstantial evi-dence that demonstrated knowledge that the transaction as structured wouldhinder, delay and defraud some creditors despite the legitimate businesspurpose of payment of a security interest); In re Bernard L. Mado� Inv. Securi-ties, LLC, 440 B.R. 243, 259 n.18, 53 Bankr. Ct. Dec. (CRR) 268, 64 CollierBankr. Cas. 2d (MB) 957 (Bankr. S.D. N.Y. 2010), leave to appeal denied, 2011WL 3897970 (S.D. N.Y. 2011) (noting that many courts examine “badges offraud” as a means of determining fraudulent intent based on circumstantial ev-idence) (Merkin I was discussed at length in the 2011 edition of this article,Gallagher, supra note 24, and a decision of the district court denying interlocu-tory review of the bankruptcy court decision is discussed in section III.B. of thisarticle); In re Phillips, 379 B.R. 765, 778 (Bankr. N.D. Ill. 2007) (cumulative ef-fect of the presence of numerous “badges of fraud” together with trustee's directevidence was probative of actual intent); In re MarketXT Holdings Corp., 376B.R. 390, 405 (Bankr. S.D. N.Y. 2007) (“[b]adges of fraud are ‘circumstances socommonly associated with fraudulent transfers that their presence gives rise toan inference of intent,’ and they are allowed as proof ‘due to the di�culty ofproving actual intent to hinder, delay or defraud creditors.’ ” (citations omit-ted)); In re Knippen, 355 B.R. 710, 721–22 (Bankr. N.D. Ill. 2006), judgmenta�'d, 2007 WL 1498906 (N.D. Ill. 2007) (“[b]ecause there is rarely direct evi-dence of the intent underlying a transfer of property, courts look to circumstan-tial evidence, referred to as the badges of fraud, in determining whether atransfer was intended to hinder, delay, or defraud creditors”); In re CassandraGroup, 338 B.R. 583, 598 (Bankr. S.D. N.Y. 2006) (“[r]ecognizing that it is typi-cally di�cult to demonstrate intent by direct evidence, the courts have identi-�ed various badges of fraud that serve as circumstantial evidence of actualintent”); cf. In re Triple S Restaurants, Inc., 422 F.3d 405, 414–16, 45 Bankr.Ct. Dec. (CRR) 57, Bankr. L. Rep. (CCH) P 80348, 2005 Fed. App. 0371P (6thCir. 2005) (discussing, among various other factors, the “badges of fraud” inher-ent in the transactions); In re McCarn's Allstate Finance, Inc., 326 B.R. 843,849–50, 44 Bankr. Ct. Dec. (CRR) 275 (Bankr. M.D. Fla. 2005) (courts look to“badges of fraud” to determine if circumstantial evidence supports an inferenceof intent to perpetrate actual fraud); In re Park South Securities, LLC., 326 B.R.505, 517–18 (Bankr. S.D. N.Y. 2005) (due to a trustee's status as an outsider,courts will accept circumstantial evidence to establish fraudulent intent, includ-ing “badges of fraud”).

25See, e.g., In re TOUSA, Inc., 444 B.R. 613, 660 (S.D. Fla. 2011); see also

In re Southeast Wa�es, LLC, 460 B.R. 132, 139–40, 55 Bankr. Ct. Dec. (CRR)233, Bankr. L. Rep. (CCH) P 82115, 2011-2 U.S. Tax Cas. (CCH) P 50740, 108A.F.T.R.2d 2011-7337 (B.A.P. 6th Cir. 2011) (although reasonably equivalentvalue typically is a question of fact, payment prior to bankruptcy of tax penaltythat reduced debtor's tax liability on a dollar for dollar basis was made for rea-


1032

As noted above, however, BAPCPA has added a fourth subtest—one speci�cally targeted at employment contracts. This additionof the fourth subtest is the second change to section 548 with re-spect to insiders under employment contracts.26 This change hasmore teeth than the �rst, but may result in a lessening of thepreventive nature of section 548 in this regard because the inclu-

sonably equivalent value); In re Kendall, 440 B.R. 526, 532–33, 64 Collier Bankr.Cas. 2d (MB) 1404, Bankr. L. Rep. (CCH) P 81898 (B.A.P. 8th Cir. 2010) (thequestion of receipt of reasonably equivalent value is a factual determinationand �nding that, with respect to indirect bene�ts, value is conferred “so long asthere is some chance that a contemplated investment will generate a positivereturn at the time of the disputed transfer”); In re TriGem America Corp., 431B.R. 855, 867, 53 Bankr. Ct. Dec. (CRR) 110 (Bankr. C.D. Cal. 2010) (indirectbene�ts can su�ce as reasonably equivalent value “if they are ‘fairly concreteand identi�able.’ ”) (citing In re TOUSA, Inc., 422 B.R. 783, 846–50 (Bankr. S.D.Fla. 2009)); In re Goldstein, 428 B.R. 733, 736, 64 Collier Bankr. Cas. 2d (MB)202 (Bankr. W.D. Mich. 2010) (holding the same); Grochocinski v. Schlossberg,402 B.R. 825, 835 n.7 (N.D. Ill. 2009) (issue of reasonably equivalent value is anelement of the prima facie case to prove fraud in law) (citing General Elec.Capital Corp. v. Lease Resolution Corp., 128 F.3d 1074, 1079, 47 Fed. R. Evid.Serv. 1074 (7th Cir. 1997)); In re EBC I, Inc., 356 B.R. 631, 642, 47 Bankr. Ct.Dec. (CRR) 131 (Bankr. D. Del. 2006) (to the extent debtor paid more to defen-dant than the value of the services received, the termination of the contracteliminated that value, and thus the debtor received less than reasonably equiv-alent value); In re Knippen, 355 B.R. at 710 (the determination of “reasonablyequivalent value” under § 548(a)(1)(B) is a two-step process where the courtmust �rst determine whether the debtor received value, and then examinewhether the value is reasonably equivalent to what the debtor gave up); In reTerry Mfg. Co., Inc., 358 B.R. 429, 434, 47 Bankr. Ct. Dec. (CRR) 110 (Bankr.M.D. Ala. 2006) (“reasonably equivalent value” is a fact-intensive question, notgenerally appropriate for summary judgment); see also In re NorthernMerchandise, Inc., 371 F.3d 1056, 1058–59, 43 Bankr. Ct. Dec. (CRR) 49, Bankr.L. Rep. (CCH) P 80112 (9th Cir. 2004) (�nding reasonably equivalent value inreturn for security interests granted by debtor to secure loan to shareholders,when debtor actually bene�ted from the loan); Pension Transfer Corp. v. Bene�-ciaries Under Third Amendment To Fruehauf Trailer Corporation RetirementPlan No. 003, 319 B.R. 76, 86, 34 Employee Bene�ts Cas. (BNA) 1361 (D. Del.2005), a�'d, 444 F.3d 203, 46 Bankr. Ct. Dec. (CRR) 100, 37 Employee Bene�tsCas. (BNA) 1796, Bankr. L. Rep. (CCH) P 80483 (3d Cir. 2006) (the opportunityto receive economic bene�t in the future is “value” under the Bankruptcy Code);In re Denison, 292 B.R. 150, 154–55 (E.D. Mich. 2003) (contractual rights tofuture consideration can provide reasonably equivalent value); In re Solomon,300 B.R. 57, 64–7 (Bankr. N.D. Okla. 2003), order a�'d, 299 B.R. 626 (B.A.P.10th Cir. 2003) (concluding that, by operation of law, securing antecedent debtprovides value to the debtor, but that such value was not reasonably equivalentbecause, even if the lender did “provide some small measure of forbearance inexchange for the mortgages,” the deprivation of property from the debtors' othercreditors made the transaction overall lack reasonably equivalent value).

26The �rst change, discussed above, did little to broaden an already

expansive de�nition of “transfer” in these provisions.


1033

sion of a subtest speci�cally addressing transfers under employ-ment contracts with respect to insiders27 may actually act to barrecovery in such instances. By including such a provision in theconstructive fraud section, Congress �rst requires such transfersto be for less than reasonably equivalent value, a subject of muchdebate. Further, the “not in the ordinary course” languageincluded in the subtest may prove di�cult to satisfy.28

Section 548 contains a number of provisions other than theactual and constructive fraud provisions in section 548(a)(1). Sec-tion 548(a)(2), for example, codi�es the Charitable Donation Act,as follows:

(a)(2) A transfer of a charitable contribution to a quali�ed religiousor charitable entity or organization shall not be considered to be atransfer covered under paragraph (1)(B) in any case in which-

(A) the amount of that contribution does not exceed 15 percentof the gross annual income of the debtor for the year in which thetransfer of the contribution is made;29 or

(B) the contribution made by a debtor exceeded the percentageamount of gross annual income speci�ed in subparagraph (A), ifthe transfer was consistent with the practices of the debtor inmaking charitable contributions.

2711 U.S.C. § 548(a)(1)(B)(ii)(IV) (deeming constructively fraudulent and

avoidable transfers made or obligations incurred for less than reasonably equiv-alent value “to or for the bene�t of an insider, under an employment contractand not in the ordinary course of business”).

28Two recent decisions discussed at length in the 2011 edition of this article

held that severance payments to former insiders were constructively fraudulentunder section 548(a)(1)(B) because even though the executives were not insiderswhen the payments were made, they were insiders at the time the paymentswere arranged. See In re TransTexas Gas Corp., 597 F.3d 298, 52 Bankr. Ct.Dec. (CRR) 199, Bankr. L. Rep. (CCH) P 81684 (5th Cir. 2010); In re TSIC, Inc.,428 B.R. 103 (Bankr. D. Del. 2010). The defense asserting that executives werenot insiders when the severance was paid failed because insider status isdetermined when the obligation to pay severance is incurred. The argumentthat prior services provided the reasonably equivalent value required to defeatan action seeking to avoid severance as a constructivly fraudulent transferunder section 548(a)(1)(B)(ii)(IV) was not successful. Id.; see also Gallagher,supra note 24.

29One court determined that where a debtor's business is a sole proprietor-

ship, the debtor's “gross income” for purposes of calculating charitable contribu-tions under section 548(a)(2) shall be the debtor's gross receipts, withoutsubtracting the cost of goods or operating expenses. In re Lewis, 401 B.R. 431,445, 61 Collier Bankr. Cas. 2d (MB) 1051, Bankr. L. Rep. (CCH) P 81452 (Bankr.C.D. Cal. 2009).


1034

The Charitable Donation Act also amended section 544(b),preempting any attempt to use that section to avoid a charitabledonation otherwise protected under section 548(a)(2).30

Bankruptcy courts have reviewed the plain meaning of the sec-tion, and concluded that the 15 percent limitation in section548(a)(2)(A) is, in essence, a qualifying criterion for a transfer,not a measuring device for propriety.31 Thus, if a transfer exceedsthe 15 percent mark, even by a penny, the entire transfer willnot be a�orded the protections of section 548(a)(2)(A).32 Anotherproblem with section 548(a)(2) is that, as drafted, the provisionapplies to single transfers.33 Thus, while a single transfer in andof itself may not exceed the limitation, aggregated transferswithin a single year may do so and the language of this sectioncalls into question whether they would still be a�orded protection.A court that considered what was required for a transfer to be“consistent with the practices of the debtor” determined that a$20,000 donation was inconsistent with practices when the larg-est previous donation was $2,000, and exceeded annual cumula-tive donations in past years.34 One should also note that in order

30Section 544(b)(2) now provides as follows:

Paragraph (1) shall not apply to a transfer of a charitable contribution (as that termis de�ned in section 548(d)(3)) that is not covered under section 548(a)(1)(B), by rea-son of section 548(a)(2). Any claim by any person to recover a transferred contributiondescribed in the preceding sentence under Federal or State law in a Federal or Statecourt shall be preempted by the commencement of the case.

11 U.S.C. § 544(b)(2). As stated by the Ninth Circuit Bankruptcy AppellatePanel, “with the 1998 [Charitable Donation] Act, Congress unequivocallyestablished the priority of charitable contributions. The clear and unmistakablemessage is that the interests of creditors are subordinate to the interests ofcharitable organizations, and we must follow this mandate.” In re Cavanagh,250 B.R. 107, 113, 36 Bankr. Ct. Dec. (CRR) 100, Bankr. L. Rep. (CCH) P 78233(B.A.P. 9th Cir. 2000) (using § 548(a)(2) to provide guidance for a Chapter 13plan).

31In re Zohdi, 234 B.R. 371, 374–84, 34 Bankr. Ct. Dec. (CRR) 609, 42

Collier Bankr. Cas. 2d (MB) 453 (Bankr. M.D. La. 1999); see also In re Witt, 231B.R. 92, 97–100, 34 Bankr. Ct. Dec. (CRR) 22 (Bankr. N.D. Okla. 1999) (�nding§ 548(a)(2) to be constitutional).

32It still may be a�orded protection under § 548(a)(2)(B), if applicable. See

In re Zohdi, 234 B.R. at 374–85.33

Id. at 380 n.20.34

In re Jackson, 249 B.R. 373, 377 (Bankr. D. N.J. 2000).


1035

to invoke the protections of the Charitable Donation Act in thisregard, the debtor must be a “natural person.”35

Section 548(b) sets out the avoidance powers by the trustee of apartnership debtor of transfers to general partners of the debtor,36

and is rarely litigated.37

Section 548(c) contains a “savings clause” that protectstransferees who would otherwise be subject to section 548 avoid-ance if they took “for value and in good faith” by granting suchtransferees lien rights, retained interests or enforcement rights,as the case may be, with respect to the interest transferred orobligation incurred to the extent that the transferees gave valueto the debtor in exchange for such transfer or obligation.38 Unlessthe transferee demonstrates39 good faith and value,40 the trustee

3511 U.S.C. § 548(d)(3)(A); Universal Church v. Geltzer, 463 F.3d 218,

Bankr. L. Rep. (CCH) P 80725, 36 A.L.R. Fed. 2d 649 (2d Cir. 2006); In re C.F.Foods, L.P., 280 B.R. 103, 111 n.17 (Bankr. E.D. Pa. 2002).

36Section 548(b) provides:

The trustee of a partnership debtor may avoid any transfer of an interest of thedebtor in property, or any obligation incurred by the debtor, that was made orincurred on or within 2 years before the date of the �ling of the petition, to a generalpartner in the debtor, if the debtor was insolvent on the date such transfer was madeor such obligation was incurred, or became insolvent as a result of such transfer orobligation.

11 U.S.C. § 548(b).37

See In re Labrum & Doak, LLP, 227 B.R. 383, 386–87, 33 Bankr. Ct. Dec.(CRR) 598 (Bankr. E.D. Pa. 1998) (dissolved law �rm's general partners whoreceived payments otherwise in violation of § 548(b) may retain the payments ifthe criteria of § 548(c) savings clause are met); In re 1634 Associates, 157 B.R.231, 233–34, 24 Bankr. Ct. Dec. (CRR) 957 (Bankr. S.D. N.Y. 1993) (holdingthat § 548(b) applies to indirect transfers made for the bene�t of generalpartners); see also In re Prime Realty, Inc., 380 B.R. 529, 537 n.2, 49 Bankr. Ct.Dec. (CRR) 71 (B.A.P. 8th Cir. 2007) (�nding that the debtor's long-term obliga-tions to its limited partners pursuant to purchase contracts were not consideredliabilities on its balance sheet in its insolvency analysis).

38Section 548(c) provides:

Except to the extent that a transfer or obligation voidable under this section is void-able under section 544, 545, or 547 of this title, a transferee or obligee of such atransfer or obligation that takes for value and in good faith has a lien on or mayretain any interest transferred or may enforce any obligation incurred, as the casemay be, to the extent that such transferee or obligee gave value to the debtor inexchange for such transfer or obligation.

11 U.S.C. § 548(c).39

The defendant has the burden of showing good faith and value forpurposes of section 548(c). See generally 5 Collier on Bankruptcy ¶¶ 548.09[2][c]and 548.11[1][b][iii] (Alan J. Resnick and Henry J. Sommer eds., 16th ed. 2012).


1036

will prevail.41 Section 548(c) has been the topic of muchlitigation.42

Section 548(d) amounts to what is essentially a subsectioncontaining de�nitions used in the section, and is too lengthy toset forth herein in its entirety.43 Except for the safe harbor provi-

40Value for purposes of section 548 is de�ned as “property, or satisfaction

or securing of a present or antecedent debt of the debtor, but does not includean unperformed promise to furnish support to the debtor or to a relative of thedebtor.”11 U.S.C. § 548(d)(2)(A).

41See In re Rosen Auto Leasing, Inc., 346 B.R. 798, 805–06, 46 Bankr. Ct.

Dec. (CRR) 235 (B.A.P. 8th Cir. 2006).42

See In re Dreier LLP, 462 B.R. 474, 487 (Bankr. S.D. N.Y. 2011) (holding,among other things, that where complaint does not establish defendant's a�r-mative good faith defense, defendant's motion to dismiss on that basis would bedenied); In re Bernard L. Mado� Inv. Securities LLC, 458 B.R. 87, 105, 55Bankr. Ct. Dec. (CRR) 139 (Bankr. S.D. N.Y. 2011), leave to appeal denied, 464B.R. 578 (S.D. N.Y. 2011); In re Bayou Group, LLC, 439 B.R. 284, 308 (S.D.N.Y. 2010) (a transferee bears the burden of “proving that it took: (1) ‘for value. . . to the extent that [it] gave value’ to the debtor in exchange for such transferand (2) ‘in good faith.’ ”); In re Hill, 342 B.R. 183, 203 (Bankr. D. N.J. 2006)(utilization of the good faith defense requires proof of two elements: �rst, in-nocence on the part of the transferee, and second, an exchange of value); seealso In re Northern Merchandise, Inc., 371 F.3d 1056, 1060, 43 Bankr. Ct. Dec.(CRR) 49, Bankr. L. Rep. (CCH) P 80112 (9th Cir. 2004) (�nding good faithwhere a loan incurred by a debtor's shareholders for the bene�t of the debtorwas secured with corporate assets, as value given to the debtor's estate); In reFoxmeyer Corp., 296 B.R. 327, 341–42, 41 Bankr. Ct. Dec. (CRR) 225 (Bankr. D.Del. 2003) (good faith determination survives a motion for judgment as a matterof law); In re H. King & Associates, 295 B.R. 246, 285–86 (Bankr. N.D. Ill. 2003)(holding that section 548(c), not section § 550(b), is the appropriate and solegood faith defense for initial transferees of fraudulent conveyances). It is notnecessarily dispositive that a transaction be entered into at arm's length. See Inre e2 Communications, Inc., 320 B.R. 849, 858, 43 Bankr. Ct. Dec. (CRR) 277(Bankr. N.D. Tex. 2004) (stating that “how arm's-length negotiations leading upto the execution of the [agreement] is relevant to this avoidance action is notexplained by the Defendant. The Court sees little, if any, relevance at this time.Rather, what is relevant to a fraudulent transfer claim is the Debtor's intent inentering into the transaction . . .”). But see In re Jones, 304 B.R. 462, 475–76,51 Collier Bankr. Cas. 2d (MB) 874 (Bankr. N.D. Ala. 2003) (�nding good faithin an arm's length pawn transaction even though the debtor received far lessthan reasonably equivalent value in the transaction).

43BAPCPA changed section 548(d) in a manner consistent with the changes

to section 546 noted below, namely to include “�nancial participants” to the gen-eral protections contained in section 548(d)(2)(B)–(D) (creating statutory de�ni-tions of when a transfer is “for value” with respect to certain securities transac-tions). Similarly, BAPCPA added a new section 548(d)(2)(E) which included, inparallel to the addition of section 546(j), “master netting agreements” to thosetransfers that are statutorily “for value.”


1037

sion litigated on several occasions in 2001,44 section 548(d) israrely the subject of litigation.45

Section 548(e) addresses transfers to asset protection trusts.Under section 548(e), a trustee can avoid a debtor's transfer of aninterest in property made within 10 years of the �ling if thetransfer was made to a self-settled trust or similar device by thedebtor for the bene�t of the debtor and the transfer was madewith the actual intent to hinder, delay or defraud any creditor.This section was added by BAPCPA and is targeted at personswho seek to use self-settled trusts to avoid paying creditors. Com-monly referred to as the “millionaire's loophole,”46 the provisionwas intended to curb the move by several states to exempt suchself-settled trusts from bankruptcy treatment. The methodologyof section 548(e) stems from the language of section 541 of theBankruptcy Code (the statute de�ning property of a debtor'sestate).47 Under section 541(c)(2), restrictions on the transfer ofbene�cial interests in trusts that are “enforceable under ap-plicable non-bankruptcy law” are made enforceable in a bank-ruptcy case (thereby causing such property to be excluded from

44In re Paramount Citrus, Inc., 268 B.R. 620, 624–26 (M.D. Fla. 2001) (sec-

tion 548(d)(2)(B) cannot be used to shelter a transfer unless the debtor itselfhad an account with the commodity broker); In re Adler, Coleman ClearingCorp., 263 B.R. 406, 480–85, 44 U.C.C. Rep. Serv. 2d 1125 (S.D. N.Y. 2001). Onthe opposite end of the spectrum from the safe harbor provisions, there is aquestion as to whether a committee or trustee pursuing a fraudulent transferaction is subject to defenses arising from the debtor's fraudulent conduct.Compare In re Personal and Business Ins. Agency, 334 F.3d 239, 41 Bankr. Ct.Dec. (CRR) 134, Bankr. L. Rep. (CCH) P 78871 (3d Cir. 2003) (Chapter 7 trusteenot subject to defenses when bringing action under section 548) with O�cialCommittee of Unsecured Creditors v. R.F. La�erty & Co., Inc., 267 F.3d 340,359–60, 38 Bankr. Ct. Dec. (CRR) 147 (3d Cir. 2001) (committee subject to de-fenses when bringing an action under section 541).

45See Frierdich v. Mottaz, 294 F.3d 864, 867, 39 Bankr. Ct. Dec. (CRR) 210,

Bankr. L. Rep. (CCH) P 78674, 47 U.C.C. Rep. Serv. 2d 1451 (7th Cir. 2002)(de�nition of “transfer” under section 548(d)(1)); see also Anand v. NationalRepublic Bank of Chicago, 239 B.R. 511, 517, 42 Collier Bankr. Cas. 2d (MB)1528 (N.D. Ill. 1999) (while collateralization of an antecedent debt may a�ordthe debtor reasonably equivalent value under section 548(a)(l)(B)(i), reasonablyequivalent value must be determined on a case-by-case basis).

46The language in section 548(e) was chosen over competing changes

introduced in the House of Representatives under the title of the “Billionaire'sLoophole Elimination Act.” H.R. 1278, 109th Cong., 1st Sess. (March 14, 2005).

4711 U.S.C. § 541(c)(2).


1038

the debtor's bankruptcy estate).48 Rather than revise section 541,however, Congress chose instead to alter the application of sec-tion 548 by implementing section 548(e).49 The result is that atrustee can avoid a debtor's transfer of an interest in propertymade within 10 years of the �ling if the transfer was made to aself-settled trust or similar device by the debtor for the bene�t ofthe debtor and the transfer was made with the actual intent tohinder, delay or defraud any creditor.50

48Gretchen Morgenson, Proposed Law on Bankruptcy Has Loophole, N.Y.

Times, March 2, 2005. Five states (Alaska, Delaware, Nevada, Rhode Islandand Utah) enacted such laws between 1997 and the implementation of BAPCPA.Id.

49Section 548(e) reads as follows:

(e)(1) In addition to any transfer that the trustee may otherwise avoid, the trusteemay avoid any transfer of an interest of the debtor in property that was made on orwithin 10 years before the date of the �ling of the petition, if:

(A) such transfer was made to a self-settled trust or similar device;(B) such transfer was by the debtor;(C) the debtor is a bene�ciary of such trust or similar device; and(D) the debtor made such transfer with actual intent to hinder, delay, or

defraud any entity to which the debtor was or became, on or after the date thatsuch transfer was made, indebted.(2) For the purposes of this subsection, a transfer includes a transfer made in

anticipation of any money judgment, settlement, civil penalty, equitable order, orcriminal �ne incurred by, or which the debtor believed would be incurred by:

(A) any violation of the securities laws (as de�ned in section 3(a)(47) of theSecurities Exchange Act of 1934 (15 U.S.C. 78c(a)(47))), any State securities laws,or any regulation or order issued under Federal securities laws or State securi-ties laws; or

(B) fraud, deceit, or manipulation in a �duciary capacity or in connection withthe purchase or sale of any security registered under section 12 or 15(d) of theSecurities Exchange Act of 1934 (15 U.S.C. 78l and 78o(d)) or under section 6 ofthe Securities Act of 1933 (15 U.S.C. 77f).

11 U.S.C. § 548 (e).50

It should be noted that, unlike the changes with respect to insidertransfers, this provision is somewhat elegant in nature. By permitting thetrustee to avoid the transfer to the trust (or similar device), Congress need notengage in tricky rulemaking with respect to section 541(c)(2). States remainfree to protect such trusts but, if the transfers are fraudulent, the trust may bedeemed to fail regardless. As with most of BAPCPA's changes to section 548,section 548(e) was e�ective immediately upon enactment to cases commencedon or after that date. The impact of section 548(e) has been discussed in severalcases. See In re Mortensen, 2011 WL 5025249, *6–8 (Bankr. D. Alaska 2011)(transfers to a self-settled trust avoidable as fraudulent); see also In re Porco,Inc., 447 B.R. 590, 594–97, 54 Bankr. Ct. Dec. (CRR) 153, Bankr. L. Rep. (CCH)P 81989 (Bankr. S.D. Ill. 2011) (constructive trust not a “similar device” to self-settled asset protection trust for avoidance under section 548(e)); In re Mastro,465 B.R. 576 (Bankr. W.D. Wash. 2011) (transfers to self-settled trusts wereavoidable as fraudulent); In re Potter, 2008 WL 5157877, *8 (Bankr. D. N.M.


1039

BAPCPA also made a number of changes to the treatment of�nancial contracts, as such are governed by section 548 and re-lated sections of the Bankruptcy Code. Under these provisions,transfers that are margin or settlement payments made by or toa commodity broker, forward contract merchant, stockbroker,�nancial institution, �nancial participant,51 or securities clearingagency,52 or to a repurchase participant or �nancial participant inconnection with a repurchase agreement53 may only be avoided ifactually fraudulent under section 548(a)(1)(A), but not if merelyconstructively fraudulent under section 548(a)(1)(B).54 The sameapplies to transfers made by or to a swap participant or �nancial

2008) (holding that section 548(e) applied to a trust even when the debtor wasone of multiple bene�ciaries and that transfers by a limited liability company tothe trust were considered “by” the debtor when he was the sole member of thelimited liability company); In re Combes, 382 B.R. 186, 193–94 (Bankr. E.D.N.Y. 2008) (court declined to address whether the purchase of an annuity couldconstitute a transfer to a “self-settled trust or similar device” under section548(e); however, the court held that in order to avoid a transfer pursuant to sec-tion 548(e)(1) the trustee must commence an adversary proceeding); In re Gould,348 B.R. 78, 80 n.18, Bankr. L. Rep. (CCH) P 80720 (Bankr. D. Mass. 2006)(discussing section 548(e) as a statutory interpretation example unrelated to itsactual content); In re Cherry, 2006 WL 3088212, *25 (Bankr. S.D. Tex. 2006)(denying standing to third-party plainti�s to bring an action under section548(e), stating that “[t]hese claims belong to the Trustee”).

5111 U.S.C. § 101(22A) (de�ning “�nancial participant”).

5211 U.S.C. § 546(e) (BAPCPA added “�nancial participant” to this group).

Section 546(e) provides:Notwithstanding [s]ections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, thetrustee may not avoid a transfer that is a margin payment, as de�ned in section 101,741, or 761 of this title, or settlement payment as de�ned in [s]ection 101 or 741 ofthis title, made by or to (or for the bene�t of) a commodity broker, forward contractmerchant, stockbroker, �nancial institution, �nancial participant, or securities clear-ing agency, or that is a transfer made by or to (or for the bene�t of) a commodity bro-ker, forward contract merchant, stockbroker, �nancial institution, �nancial partici-pant, or securities clearing agency, in connection with a securities contract, as de�nedin [s]ection 741(7), commodity contract, as de�ned in [s]ection 761(4), or forwardcontract, that is made before the commencement of the case, except under section548(a)(1)(A) of this title.

5311 U.S.C. § 546(f) (BAPCPA added “�nancial participant” to this group).

54See Picard v. Katz, 462 B.R. 447, 451–52, 55 Bankr. Ct. Dec. (CRR) 133,

Bankr. L. Rep. (CCH) P 82077 (S.D. N.Y. 2011), motion to certify appeal denied,466 B.R. 208, 55 Bankr. Ct. Dec. (CRR) 266 (S.D. N.Y. 2012); Enron CreditorsRecovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329, 332, 55 Bankr. Ct. Dec.(CRR) 12, 65 Collier Bankr. Cas. 2d (MB) 1833 (2d Cir. 2011); In re QSIHoldings, Inc., 571 F.3d 545, 548–49, 51 Bankr. Ct. Dec. (CRR) 222, Bankr. L.Rep. (CCH) P 81528 (6th Cir. 2009), cert. denied, 130 S. Ct. 1141, 175 L. Ed. 2d972 (2010).


1040

participant under or in connection with any swap agreements55

and transfers made by or to a master netting participant underor in connection with any master netting agreement or any indi-vidual contract covered thereby. As those changes relate to sec-tion 548, they include the addition of “�nancial participants” tothe various �nancial contract parties who may be deemed to takefor value under section 548(d)(2)56 and the inclusion of “masternetting agreements” to the various types of �nancial contracts af-forded the same protection.57

The former change protects parties with transactions with atotal gross dollar value of at least $1 billion in notional or actionalprincipal amount or gross mark-to-market positions of at least$100 million (aggregated across counterparties) in one or moreagreements or transactions, in any day during the previous 15-month period. As noted by the FDIC, these changes “reducesystemic risk by providing greater clarity to the rights availableto larger participants in markets.”58 The latter change parallelsthe addition of section 561 of the Bankruptcy Code, clarifying theability of counterparties to net payments across di�erent catego-ries of �nancial contracts59 by making it clear that such nettingmay be for value under section 548(d)(2).

The treatment of �nancial contracts was further modi�ed bythe passage of the Financial Netting Improvement Act of 2006

55See 11 U.S.C. § 546(g) (BAPCPA added “�nancial participant” to this

group and changed the wording of this provision) and 11 U.S.C. § 546(j) (addedby BAPCPA).

56See 11 U.S.C. § 548(d)(2)(B) to (D) (each adding “�nancial participants” to

those who may take “for value” under certain �nancial contracts); see also 11U.S.C. § 101(22A) (de�ning “�nancial participant”); cf. 11 U.S.C. § 546(e) to (g).

5711 U.S.C. § 548(d)(2)(E) (“a master netting agreement participant that

receives a transfer in connection with a master netting agreement or any indi-vidual contract covered thereby, takes for value to the extent of such transfer,except that, with respect to a transfer under any individual contract coveredthereby, to the extent that such master netting participant otherwise did nottake (or is otherwise not deemed to have taken) such transfer for value”).

58See Michael H. Krimminger, Adjusting the Rules: What Bankruptcy

Reform Will Mean for Financial Market Contracts, FYI: An Update on Emer-gency Issues on Banking, at http://www.fdic.gov/bank/analytical/fyi/2005/101105fyi.html (last modi�ed October 11, 2005).

59See 11 U.S.C. § 561; see also 11 U.S.C. §§ 101(38A) (de�ning “master net-

ting agreement”) and 101(38B) (de�ning “master netting agreementparticipant”).


1041

(the “Act of 2006”)60 which, among other things, clari�ed the typesof transfers and payments that are subject to the statutory safeharbor from avoidance actions provided by section 546(e) of theBankruptcy Code.61 The updates and revisions to the descriptionsof certain �nancial transactions were intended to better re�ectcurrent market and regulatory industry practice. Notably, in ad-dition to margin and settlement payments, which were alreadyprotected under section 546(e), the Act of 2006 expanded thisprovision to encompass transfers made to or for the bene�t of acommodity broker, forward contract merchant, stockbroker,�nancial institution, �nancial participant or securities clearingagency in connection with any securities, commodities or forwardcontracts. The Act of 2006 also expanded the section 546(e) safeharbor to include swap and repurchase agreement participantsby virtue of amending certain de�nitional provisions of the Bank-ruptcy Code.62

60See Financial Netting Improvements Act of 2006, Pub. L. No. 109-390, § 5

(2006).61

Pub. L. 109-390 (2006). The Financial Netting Improvement Act of 2006also amends provisions of the Bankruptcy Code to conform with parallel provi-sions in the Federal Deposit Insurance Act and the Federal Credit Union Act.

62Section 546(e) of the Bankruptcy Code insulates “margin payments” and

“settlement payments” made to or by a broker or �nancial institution from chal-lenge as fraudulent transfers, absent a showing of actual fraudulent intent.“Settlement payments” are de�ned by section 741(8) of the Bankruptcy Code, insubstance, as settlement payments or similar payments commonly used in thesecurities trade. See supra note 52 for the language of section 546(e). Recent de-cisions addressing the safe harbor provided by section 546(e) include: EnronCreditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329, 55 Bankr. Ct.Dec. (CRR) 12, 65 Collier Bankr. Cas. 2d (MB) 1833 (2d Cir. 2011) (safe harborprotected from avoidance early redemption payments of commercial paper as“settlement payments” within the meaning of section 741(8)); Picard v. Katz,462 B.R. 447, 55 Bankr. Ct. Dec. (CRR) 133, Bankr. L. Rep. (CCH) P 82077(S.D. N.Y. 2011), motion to certify appeal denied, 466 B.R. 208, 55 Bankr. Ct.Dec. (CRR) 266 (S.D. N.Y. 2012); In re Magnesium Corp. of America, 460 B.R.360 (Bankr. S.D. N.Y. 2011); In re Renew Energy LLC, 463 B.R. 475, 55 Bankr.Ct. Dec. (CRR) 106, 66 Collier Bankr. Cas. 2d (MB) 636, Bankr. L. Rep. (CCH)P 82061 (Bankr. W.D. Wis. 2011); In re Quebecor World (USA) Inc., 453 B.R.201, 55 Bankr. Ct. Dec. (CRR) 60 (Bankr. S.D. N.Y. 2011); In re MacMenamin'sGrill Ltd., 450 B.R. 414 (Bankr. S.D. N.Y. 2011); In re D.E.I. Systems, Inc., 2011WL 1261603 (Bankr. D. Utah 2011); In re Mervyn's Holdings, LLC, 426 B.R.488 (Bankr. D. Del. 2010). Several decisions, discussed in the 2010 edition ofthis article, address the avoidance of payments and transfers made in connec-tion with leveraged buyouts as fraudulent transfers and whether such pay-ments fall within the safe harbor of section 546(e). Sheikh, supra note 3, atIII.C. See, e.g., In re Plassein Intern. Corp., 590 F.3d 252, 52 Bankr. Ct. Dec.(CRR) 145, Bankr. L. Rep. (CCH) P 81653 (3d Cir. 2009), cert. denied, 130 S. Ct.


1042

Finally, BAPCPA granted speci�c powers to foreign representa-tives under Chapter 15 of the Bankruptcy Code to invoke andutilize the power to avoid fraudulent transfers under section 548through the inclusion of sections 1521(a)(7) and 1523(a) of theBankruptcy Code.63 There is recent case law interpreting thesesections.64

2389, 176 L. Ed. 2d 769 (2010); In re QSI Holdings, Inc., 571 F.3d 545, 51Bankr. Ct. Dec. (CRR) 222, Bankr. L. Rep. (CCH) P 81528 (6th Cir. 2009), cert.denied, 130 S. Ct. 1141, 175 L. Ed. 2d 972 (2010); Contemporary IndustriesCorp. v. Frost, 564 F.3d 981, 51 Bankr. Ct. Dec. (CRR) 157, Bankr. L. Rep.(CCH) P 81473 (8th Cir. 2009).

6311 U.S.C. §§ 1521, 1523 (2009) (each addressing a foreign representative's

right to utilize sections 548 and 550 upon recognition of a foreign proceeding).Section 1521(a)(7) appears to allow a court to grant a foreign representativecertain limited independent avoidance powers in the action pending underChapter 15, while section 1523(a) appears to permit the foreign representativeto exercise those broader avoidance powers should a case concerning the debtorexist under another Chapter of the Bankruptcy Code.

Section 1521 provides in relevant part:(a) Upon recognition of a foreign proceeding, whether main or non-main, where

necessary to e�ectuate the purpose of this chapter and to protect the assets ofthe debtor or the interest of the creditors, the court may, at the request of theforeign representative, grant any appropriate relief, including—

(7) granting any additional relief that may be available to a trustee, except forrelief available under sections 522, 544, 545, 547, 548, 550, and 724(a).

11 U.S.C. § 1521(a).Section 1523 provides in relevant part:

(a) Upon recognition of a foreign proceeding, the foreign representative has stand-ing in a case concerning the debtor pending under another chapter of this titleto initiate actions under sections 522, 544, 545, 547, 548, 550, 553, and 724(a).

11 U.S.C. § 1523(a).64

See In re Condor Ins. Ltd., 601 F.3d 319, 328–29, 52 Bankr. Ct. Dec.(CRR) 256, Bankr. L. Rep. (CCH) P 81712 (5th Cir. 2010) (allowing a foreignrepresentative to use foreign avoidance law even though no Chapter 7 orChapter 11 case is �led in the United States). In re Condor Ins. Ltd. wasdiscussed in detail in section III.D. of the 2011 edition of this article. Gallagher,supra note 24. A recent bankruptcy court decision favorably cited the FifthCircuit's holding in In re Condor Ins. Ltd. that a bankruptcy court has theauthority under Chapter 15 of the Bankruptcy Code to decide an avoidanceclaim based on foreign law. In re International Banking Corp. B.S.C., 439 B.R.614, 629, 53 Bankr. Ct. Dec. (CRR) 279 (Bankr. S.D. N.Y. 2010); see also In reFair�eld Sentry Ltd. Litigation, 458 B.R. 665 (S.D. N.Y. 2011) (reversing bank-ruptcy court and holding that bankruptcy court lacked jurisdiction over claimsof Foreign Representatives of o�shore funds because the assets sought were lo-cated outside of the United States); In re Awal Bank, BSC, 455 B.R. 73, 55Bankr. Ct. Dec. (CRR) 97, 75 U.C.C. Rep. Serv. 2d 245 (Bankr. S.D. N.Y. 2011)(External Administrator's action to recover a set-o� pursuant to § 553(b) notprecluded by § 1521(a)(7) of the Bankruptcy Code); In re Atlas Shipping A/S,404 B.R. 726, 744, 51 Bankr. Ct. Dec. (CRR) 145, 61 Collier Bankr. Cas. 2d


1043

B. History and Construction of Section 550In enacting the Bankruptcy Code, Congress took steps to elim-

inate prior confusion regarding avoidance recoveries under theBankruptcy Act. Prior to the Bankruptcy Code:

each avoidance section included its own recovery scheme. See, e.g.,11 U.S.C. § 67 et seq. (repealed). However, when [sic] the enact-ment of the current Bankruptcy Code which repealed the previousBankruptcy Act, [s]ections 544, 545, 547, 548, and 549 govern avoid-ance while [s]ection 550 alone governs whether, and to what extent,such avoided transfers may be recovered. According to a House ofRepresentatives Report, “[s]ection 550 . . . enunciates the separa-tion between the concepts of avoiding a transfer and recoveringfrom a transferee.”65

As one court stated, “[b]y passing section 550, Congress hopedto preclude multiple transfers or convoluted business transac-tions from frustrating the recovery of avoidable transfers. Suchrecovery problems existed under the former Bankruptcy Act of1898.”66 As noted below with respect to Deprizio,67 these recoveryproblems have persisted and have been the subject of attempts tore�ne the language of section 550 to address them. Further, sec-tion 550 has been the subject of a number of other challenges. Ithas survived challenges based on the “presumption against extra-territoriality”68 and also has survived at least one sovereign im-munity challenge in which the Supreme Court held that Congress

(MB) 1141, 2009 A.M.C. 1150 (Bankr. S.D. N.Y. 2009) (a non-fraudulent transfercase stating in dicta that it is unclear whether Chapter 15 “precludes a foreignrepresentative from bringing an avoidance action under foreign law”).

65In re Coleman, 299 B.R. 780, 788–89, 92 A.F.T.R.2d 2003-7145 (W.D. Va.

2003) (citing H.R. Rep. No. 595, 95th Cong., 1st Sess. 375 (1977), reprinted in1978 U.S.C.C.A.N. pp. 5787, 5963, 6331); see also In re Burns, 322 F.3d 421,427, 40 Bankr. Ct. Dec. (CRR) 282, 49 Collier Bankr. Cas. 2d (MB) 856, Bankr.L. Rep. (CCH) P 78813, 2003 Fed. App. 0071P (6th Cir. 2003) (“[A]voidance andrecovery are distinct concepts and processes. This is clear from both the statuteitself and from its legislative history. Avoidance and recovery are addressed intwo separate sections of the code . . .”). For an instructive case on avoidanceversus recovery, see In re Connolly North America, LLC, 340 B.R. 829, 46Bankr. Ct. Dec. (CRR) 97 (Bankr. E.D. Mich. 2006).

66In re Fabric Buys of Jericho, Inc., 33 B.R. 334, 336–37, 11 Bankr. Ct. Dec.

(CRR) 109 (Bankr. S.D. N.Y. 1983) (citing 4 Collier on Bankruptcy ¶ 67.41[8](James W. Moore ed., 14th ed. 1982)) (addressing problems regarding transfersamong family-owned operations or corporations with single shareholders).

67Levit v. Ingersoll Rand Financial Corp., 874 F.2d 1186, 19 Bankr. Ct.

Dec. (CRR) 574, 22 Collier Bankr. Cas. 2d (MB) 36, 11 Employee Bene�ts Cas.(BNA) 1323, Bankr. L. Rep. (CCH) P 72910 (7th Cir. 1989).

68In re French, 440 F.3d 145, 151, 46 Bankr. Ct. Dec. (CRR) 1, 55 Collier

Bankr. Cas. 2d (MB) 806 (4th Cir. 2006) (“all of a debtor's property, whether do-


1044

had the “power to authorize courts to avoid preferential transfersand to recover the transferred property” via an action under sec-tion 550 and that this authority “operates free and clear of [astate's] claim of sovereign immunity.”69

mestic or foreign, is ‘property of the estate’ subject to the bankruptcy court's inrem jurisdiction”) (relying on In re Simon, 153 F.3d 991, 996, 33 Bankr. Ct. Dec.(CRR) 141, Bankr. L. Rep. (CCH) P 77783 (9th Cir. 1998)). In French, theFourth Circuit distinguished the presumption against extraterritoriality ruleset forth in E.E.O.C. v. Arabian American Oil Co., 499 U.S. 244, 248, 111 S. Ct.1227, 113 L. Ed. 2d 274, 55 Fair Empl. Prac. Cas. (BNA) 449, 55 Empl. Prac.Dec. (CCH) P 40607 (1991) by the application of Kollias v. D & G Marine Mainte-nance, 29 F.3d 67, 72, 1995 A.M.C. 609 (2d Cir. 1994) (courts only apply apresumption against extraterritoriality when a party seeks to enforce a statute“beyond the territorial boundaries of the United States”) and EnvironmentalDefense Fund, Inc. v. Massey, 986 F.2d 528, 531, 36 Env't. Rep. Cas. (BNA)1053, 23 Envtl. L. Rep. 20601 (D.C. Cir. 1993) (presumption has no bearingwhen “the conduct which Congress seeks to regulate occurs largely within theUnited States”). But see In re Bankruptcy Estate of Midland Euro ExchangeInc., 347 B.R. 708, 718–19, 47 Bankr. Ct. Dec. (CRR) 32, 56 Collier Bankr. Cas.2d (MB) 1041 (Bankr. C.D. Cal. 2006) (�nding “no evidence of congressionalintent to extend the application of § 548 extraterritorially . . .” and expresslydisagreeing with In re French).

69Central Virginia Community College v. Katz, 546 U.S. 356, 369–70, 126

S. Ct. 990, 163 L. Ed. 2d 945, 45 Bankr. Ct. Dec. (CRR) 254, 54 Collier Bankr.Cas. 2d (MB) 1233, Bankr. L. Rep. (CCH) P 80443 (2006) (holding that “[b]ank-ruptcy jurisdiction is principally in rem jurisdiction . . .. As such, its exercisedoes not, in the usual case, interfere with state sovereignty even when States'interests are a�ected”). Although the Supreme Court in Katz declined to decide“whether actions to recover preferential transfers pursuant to [§ 550] arethemselves properly characterized as in rem,” the Supreme Court noted that“[w]hatever the appropriate appellation, those who crafted the BankruptcyClause would have understood it to give Congress the power to authorize courtsto avoid preferential transfers and to recover the transferred property” fromstates. Id. at 372. The Supreme Court also noted that it was not bound by“statements in both the majority and the dissenting opinions” in Seminole Tribeof Florida v. Florida, 517 U.S. 44, 116 S. Ct. 1114, 134 L. Ed. 2d 252, 34 CollierBankr. Cas. 2d (MB) 1199, 42 Env't. Rep. Cas. (BNA) 1289, 67 Empl. Prac. Dec.(CCH) P 43952 (1996) (holding that the States' sovereign immunity can only beabrogated by an express statement by Congress made pursuant to a valid grantof congressional power) as the issue in Katz was not one of abrogation. Id. at363. But see In re 360networks (USA), Inc., 316 B.R. 797, 43 Bankr. Ct. Dec.(CRR) 275, 53 Collier Bankr. Cas. 2d (MB) 339 (Bankr. S.D. N.Y. 2004). In360networks, the United States Bankruptcy Court for the Southern District ofNew York sought to reconcile Seminole Tribe with Tennessee Student AssistanceCorp. v. Hood, 541 U.S. 440, 453, 124 S. Ct. 1905, 158 L. Ed. 2d 764, 43 Bankr.Ct. Dec. (CRR) 1, 51 Collier Bankr. Cas. 2d (MB) 627, Bankr. L. Rep. (CCH) P80098 (2004) (�nding that a bankruptcy court's exclusive in rem jurisdictionover property of the debtor “allows it to adjudicate the debtor's . . . claimwithout in personam jurisdiction over the State”). The bankruptcy court's hold-ing was subsequently vacated by an order �led pursuant to a settlement agree-


1045

Section 550 consists of six major subsections. Section 550(a)sets forth the trustee's (or debtor-in-possession's) general recoverypowers as follows:70

(a) Except as otherwise provided in this section, to the extent that atransfer is avoided under section 544, 545, 547, 548, 549, 553(b), or724(a) of this title, the trustee may recover, for the bene�t of theestate, the property transferred, or, if the court so orders, the valueof such property, from:

(1) the initial transferee of such transfer or the entity for whosebene�t such transfer was made; or

(2) any immediate or mediate transferee of such initialtransferee.71

ment between the parties. The parties speci�cally cited the then-upcomingSupreme Court decision in Katz as a reason to grant vacature.

70Due to the renumbering of section 550 that took place with the incorpora-

tion of the 1994 Reform Act, care should be taken when researching prior cases.For example, present section 550(d) was section 550(c) prior to the revisions.

71The Court of Appeals for the Eleventh Circuit as well as other lower

courts have held that a trustee can recover from subsequent transferees without�rst avoiding an initial transfer, so long as the trustee demonstrates that theinitial transfer is avoidable; stating that “once the plainti� proves that anavoidable transfer exists, he can then skip over the initial transferee and re-cover from those next in line.” In re International Administrative Services, Inc.,408 F.3d 689, 706, 44 Bankr. Ct. Dec. (CRR) 178, Bankr. L. Rep. (CCH) P 80279(11th Cir. 2005); Picard v. Katz, 466 B.R. 208, 214, 55 Bankr. Ct. Dec. (CRR)266 (S.D. N.Y. 2012) (stating that section 550(a) permits avoidance of asubsequent transfer where the initial transfer could have been avoided); In reRichmond Produce Co., Inc., 195 B.R. 455, 463, 142 A.L.R. Fed. 715 (N.D. Cal.1996) (“[O]nce the trustee proves that a transfer is avoidable under section 548,he may seek to recover against any transferee, initial or immediate, or an entityfor whose bene�t the transfer is made.”); see also In re Taylor, 390 B.R. 654, 666(B.A.P. 9th Cir. 2008); In re AVI, Inc., 389 B.R. 721, 734–35, 50 Bankr. Ct. Dec.(CRR) 39, 59 Collier Bankr. Cas. 2d (MB) 1753 (B.A.P. 9th Cir. 2008) (relyingon Int'l Admin. Svcs., Inc. for the same proposition). But see In re Slack-HornerFoundries Co., 971 F.2d 577, 580, Bankr. L. Rep. (CCH) P 74745 (10th Cir.1992) (“[I]n order to recover from a subsequent transferee, the trustee must �rsthave the transfer of the debtor's interest to the initial transferee avoided under§ 548.”); In re Brooke Corp., 443 B.R. 847, 852 (Bankr. D. Kan. 2010) (followingthe Tenth Circuit's decision in Slack-Horner but noting that Slack-Horner is theminority position and may be wrongly decided); In re Allou Distributors, Inc.,379 B.R. 5, 19, 49 Bankr. Ct. Dec. (CRR) 29 (Bankr. E.D. N.Y. 2007) (“before thetrustee may obtain an ‘actual recovery’ from the [m]ovants under § 550(a), hemust �rst avoid the underlying initial transfers.”); In re Furs by Albert & MarcKaufman, Inc., 2006 WL 3735621, *8 (Bankr. S.D. N.Y. 2006) (essential elementof a trustee's recovery under § 550(a) was avoidance of the initial transfer); In reResource, Recycling & Remediation, Inc., 314 B.R. 62, 69, 43 Bankr. Ct. Dec.(CRR) 164, 52 Collier Bankr. Cas. 2d (MB) 1636 (Bankr. W.D. Pa. 2004) (“Sec-tion 550(a) is a recovery provision and gives rise to a secondary cause of actionwhich applies after the trustee has prevailed under one (or more) of the avoid-


1046

While recovery of the property transferred is somewhatstraightforward, what constitutes value for the purposes of sec-tion 550 is not as clear, although at least one court has ponderedthe subjective value of property in this context.72

Initially, section 550(a)(1) did not grant the ability to recoverfrom the “entity for whose bene�t such transfer was made.”73

This language was added as a part of the 1984 Amendments. Inadding this provision, Congress speci�cally noted two limitations:(i) that no duplicate recoveries should be permitted,74 and (ii) thatthe recovery is only permissible to the extent of actual avoidance.75

The Bankruptcy Code does not de�ne initial, immediate or me-

ance provisions found in the Bankruptcy Code.”); In re Morgan, 276 B.R. 785,789 (Bankr. N.D. Ohio 2001) (the statutory language of section 550 and itslegislative history leads to the conclusion that a trustee must �rst avoid anunderlying transfer before recovery). See generally In re M. Fabrikant & Sons,Inc., 394 B.R. 721, 742–46, 50 Bankr. Ct. Dec. (CRR) 192 (Bankr. S.D. N.Y.2008) (discussing the con�ict among the counts and holding that a trustee mustalways avoid a transfer against a subsequent transferee unless collateral estop-pel or res judicata applies, thus allowing a trustee to settle with the initialtransferee and pursue subsequent transferee, or pursue a subsequent transfereewhen unable to sue the initial transferees).

72Active Wear, Inc. v. Parkdale Mills, Inc., 331 B.R. 669 (W.D. Va. 2005). In

Active Wear, a creditor reclaimed from the debtor certain quantities of yarnprior to the petition date. The debtor argued that it should be allowed to recoverthe value the creditor could realize by reselling the yarn. The creditor arguedthat the value was such as could have been realized by the debtor in a liquida-tion sale. The essence of these arguments is that value is subjective—that thesame property held by di�erent parties takes on di�erent values in re�ection ofthe party by whom it is held. If so, the net result to the estate would di�erdepending on the remedy elected. The court concluded that the recoveries undersection 550 are simply di�erent sides of the same coin; that the recovery ofvalue under section 550 by a debtor is simply a procedural device that permitsthe debtor to avoid further disposition of property, but not one that permits adebtor to bene�t from an increase in value of property held by a non-debtor. Thevalue recovered would be that which the debtor would obtain should it sell theproperty. Id. at 674.

73See In re LGI Energy Solutions, Inc., 460 B.R. 720, 725, 55 Bankr. Ct.

Dec. (CRR) 235, 66 Collier Bankr. Cas. 2d (MB) 1329 (B.A.P. 8th Cir. 2011)(relying solely on language of section 550(a)(1) of the Bankruptcy Code whichstated trustee could recover from either defendant utility providers who receivedpayments from debtor utility management and billing service provider, or fromcustomers whose accounts were credited as a result of payments to utilities bydebtor). See section III.A. of this article for a detailed discussion of TOUSA II'sanalysis of section 550(b)(1).

74See 11 U.S.C. § 550(d).

7511 U.S.C. § 550(a); see 124 Cong. Rec. 32,400 (1978); see also In re Kings-

ley, 518 F.3d 874, 878, 49 Bankr. Ct. Dec. (CRR) 167, Bankr. L. Rep. (CCH) P81115 (11th Cir. 2008) (bankruptcy court may grant a credit for any repay-


1047

diate transferees nor does it de�ne the type of bene�t necessaryto make an entity a transferee. In this vein, courts have looked atthe recipient's “dominion” over the transferred property,76

whether the recipient was a “mere conduit,”77 or whether atransferee received a bene�t from the transfer,78 but no clear-cuttest exists and courts continue to struggle with this requirement.79

ments made to reduce liability following an avoidable fraudulent transfer under§ 548).

76For a case discussion of recovery from such entities, see In re Harwell,

628 F.3d 1312, 1322–23, 54 Bankr. Ct. Dec. (CRR) 12, 64 Collier Bankr. Cas. 2d(MB) 1820, Bankr. L. Rep. (CCH) P 81909 (11th Cir. 2010); Paloian v. LaSalleBank, N.A., 619 F.3d 688, 691–92, 53 Bankr. Ct. Dec. (CRR) 155, Bankr. L. Rep.(CCH) P 81840 (7th Cir. 2010) (“Paloian”) (trustee for securitized investmentpool was “initial transferee” of payments on securitized debt as the legal ownerof the trust's assets) (In re Harwell and Paloian are discussed in greater detailin section III.C. of this article); see also Rupp v. Markgraf, 95 F.3d 936, 29Bankr. Ct. Dec. (CRR) 834, 36 Collier Bankr. Cas. 2d (MB) 1312 (10th Cir.1996) (bank acting as conduit without dominion and control over fundstransferred by debtor to a third party which is not an initial transferee); BondedFinancial Services, Inc. v. European American Bank, 838 F.2d 890, 893, 17Bankr. Ct. Dec. (CRR) 299, 18 Collier Bankr. Cas. 2d (MB) 155 (7th Cir. 1988)(the “minimum requirement of status as an [initial] transferee with dominionover the money or other asset, the right to put the money to one's own purposes”)(citations omitted); In re Antex, Inc., 397 B.R. 168, 172–73, 50 Bankr. Ct. Dec.(CRR) 266, 61 Collier Bankr. Cas. 2d (MB) 15 (B.A.P. 1st Cir. 2008) (holding “itis widely accepted that a transferee is one who at least has dominion over themoney or other asset, the right to put the money to one's own purposes”) (cita-tions omitted); In re Sunglasses and Then Some, Inc., 51 Bankr. Ct. Dec. (CRR)257, 2009 WL 2058564, *4 (Bankr. D. Mass. 2009) (in interpreting the de�nitionof “transferee,” the court determined that defendant principals or the debtorcorporation did not have “dominion and control” over funds transferred directlyfrom the debtor to defendants' other corporation); In re CVEO Corp., 327 B.R.210, 216, 45 Bankr. Ct. Dec. (CRR) 30 (Bankr. D. Del. 2005) (“To have dominionand control means to be capable of using the funds for whatever purpose he orshe wishes, be it to invest in lottery tickets or uranium stocks”) (citationsomitted).

77See In re Harwell, 628 F.3d 1312, 54 Bankr. Ct. Dec. (CRR) 12, 64 Collier

Bankr. Cas. 2d (MB) 1820, Bankr. L. Rep. (CCH) P 81909 (11th Cir. 2010);Paloian, 619 F.3d at 691–692; In re Pony Exp. Delivery Services, Inc., 440 F.3d1296, 46 Bankr. Ct. Dec. (CRR) 24, Bankr. L. Rep. (CCH) P 80465 (11th Cir.2006); In re International Administrative Services, Inc., 408 F.3d 689, 44 Bankr.Ct. Dec. (CRR) 178, Bankr. L. Rep. (CCH) P 80279 (11th Cir. 2005); In re Chase& Sanborn Corp., 813 F.2d 1177, Bankr. L. Rep. (CCH) P 71753 (11th Cir.1987); In re Chase & Sanborn Corp., 848 F.2d 1196, Bankr. L. Rep. (CCH) P72363 (11th Cir. 1988); In re Warnaco Group, Inc., 97 A.F.T.R.2d 2006-958,2006 WL 278152 (S.D. N.Y. 2006); In re Elrod Holdings Corp., 394 B.R. 751, 60Collier Bankr. Cas. 2d (MB) 1020 (Bankr. D. Del. 2008).

78See Freeland v. Enodis Corp., 540 F.3d 721, 740, 50 Bankr. Ct. Dec.

(CRR) 134, 60 Collier Bankr. Cas. 2d (MB) 524, Bankr. L. Rep. (CCH) P 81315


1048

Section 550(b) provides for separate treatment of subsequenttransferees:

(b) The trustee may not recover under [sub]section (a)(2) of this sec-tion from:

(1) a transferee that takes for value, including satisfaction orsecuring of a present or antecedent debt, in good faith, andwithout knowledge of the voidability of the transfer avoided; or

(2) any immediate or mediate good faith transferee of suchtransferee.

If the recipient of a transfer otherwise avoidable under theavoidance provisions is the initial transferee, the BankruptcyCode imposes strict liability and the trustee may recover thetransfer, but if the recipient was not the initial transferee, he orshe may assert a good faith and for value defense pursuant tosection 550(b).80 Nonetheless, the legislative history to section550 makes it clear that the recovery provisions only apply to the

(7th Cir. 2008) (“requiring that the entity actually receive a bene�t from thetransfer is consistent with the well-established rule that fraudulent transferrecovery is a form of disgorgement, so that no recovery can be had from partieswho participated in a fraudulent transfer but did not bene�t from it”) (citationsomitted); In re Meredith, 527 F.3d 372, 375–77, 50 Bankr. Ct. Dec. (CRR) 45, 59Collier Bankr. Cas. 2d (MB) 1382, Bankr. L. Rep. (CCH) P 81252 (4th Cir. 2008)(CPA transferred accounting practice to his wife for a brief period; she had nocontrol and received no bene�t from the practice and, therefore, recovery undersection 550(a)(1) could not be had from her for the transfer).

79See, e.g., Paloian, 619 F.3d at 691–92 (see discussion at section III.C. of

this article); In re Meredith, 527 F.3d at 376–77, supra note 78; In re Antex,Inc., 397 B.R. at 173 (controlling a corporation and causing checks to be issueddoes not make a principal of a corporation an initial transferee, since after theissuance of checks the principal has no legal dominion and control over use ofpayment); see also In re Hurtado, 342 F.3d 528, 532–36, 41 Bankr. Ct. Dec.(CRR) 229, Bankr. L. Rep. (CCH) P 78904, 2003 Fed. App. 0312P (6th Cir.2003) (mother-in-law of debtor to whom property was transferred was the initialtransferee because, even though she followed the debtor's instructions with re-spect to disposition of the property, she nonetheless was not legally obligated todo so); In re CVEO Corp., 327 B.R. at 217 (supra note 76); In re CassandraGroup, 312 B.R. 491, 497–98, 43 Bankr. Ct. Dec. (CRR) 116 (Bankr. S.D. N.Y.2004) (�nding that, despite the fact that he paid himself out of collectedproceeds, the agent of the landlord did not have su�cient dominion over col-lected rents to make him an initial transferee).

80See, e.g., In re Nieves, 648 F.3d 232, 242, 65 Collier Bankr. Cas. 2d (MB)

1442, Bankr. L. Rep. (CCH) P 82024 (4th Cir. 2011) (subsequent transferee mayassert good faith defense, but good faith must be determined under an objectivestandard and as such courts should analyze what the transferee knew or shouldhave known); In re Red Dot Scenic, Inc., 351 F.3d 57, 58 (2d Cir. 2003) (“If therecipient of debtor funds was the initial transferee, the bankruptcy code imposesstrict liability and the bankruptcy trustee may recover the funds. See 11 U.S.C§ 550(a). If the recipient was not the initial transferee, however, he or she may


1049

extent a transaction is avoidable.81 Thus, if the underlying avoid-ance statute contains defenses,82 those defenses will be e�ectiveregardless of the strict liability of initial transferees83 provided insection 550(a).84

Section 550(c)85 was added by the 1994 Reform Act in responseto the Deprizio case regarding preferential transfers involving

assert a good faith defense.”); In re Bower, 462 B.R. 347, Bankr. L. Rep. (CCH)P 82143 (Bankr. D. Mass. 2012) (mortgage assignee who took for value notprotected by § 550(b) because a defect on the face of mortgage made assigneeaware of facts that would have alerted a reasonable person to avoidability ofmortgage under Massachusetts law); In re Resource, Recycling & Remediation,Inc., 314 B.R. 62, 70–71, 43 Bankr. Ct. Dec. (CRR) 164, 52 Collier Bankr. Cas.2d (MB) 1636 (Bankr. W.D. Pa. 2004) (employee who took property transferredby debtor to a shell corporation and subsequently abandoned it to the employeein return for disposing of barrels of ink, took “for value” under section 550(b)).Courts are split on the placement of the burden of proof under section 550(b),but it appears that the better reasoned position is that the transferee has theburden of showing good faith, value and lack of knowledge. See 5 Collier onBankruptcy ¶ 550.03[5] (Alan J. Resnick and Henry J. Sommer eds., 16th ed.2012).

81See H. R. Rep. No. 95-595 (1977); S. Rep. No. 95-989 (1978).

82See, e.g., 11 U.S.C. §§ 548(c) & 546(e).

83For cases recognizing that initial transferees of avoided transfers are

strictly liable under § 550(a), see, e.g., In re Red Dot Scenic, Inc., 351 F.3d 57,58 (2d Cir. 2003); In re Hurtado, 342 F.3d at 532–33; In re Ogden, 314 F.3d1190, 1196, 40 Bankr. Ct. Dec. (CRR) 208, Bankr. L. Rep. (CCH) P 78794 (10thCir. 2002); In re Cohen, 300 F.3d 1097, 1102, 40 Bankr. Ct. Dec. (CRR) 9, 48Collier Bankr. Cas. 2d (MB) 1397, Bankr. L. Rep. (CCH) P 78706, 48 U.C.C.Rep. Serv. 2d 469 (9th Cir. 2002).

84See In re Teleservices Group, Inc., 444 B.R. 767, 790–95 (Bankr. W.D.

Mich. 2011) (section 548(c), not section 550(b), is the sole good faith defense forinitial transferees of allegedly fraudulent transfers); In re General Search.com,322 B.R. 836, 842, 54 Collier Bankr. Cas. 2d (MB) 46 (Bankr. N.D. Ill. 2005)(same); In re H. King & Assocs., 295 B.R. at 285–86 (same); In re Food & FibreProtection, Ltd., 168 B.R. 408, 419–20, 25 Bankr. Ct. Dec. (CRR) 1019 (Bankr.D. Ariz. 1994) (same); see also Nelmark v. Helms, 2003 WL 1089363, *3–5 (N.D.Ill. 2003) (upholding bankruptcy court determination that defendants wereinitial transferees who were not entitled to defense of section 550(b) and whodid not prove they had acted in good faith for purposes of section 548(c)).

85Section 550(c) of the Bankruptcy Code provides:

If a transfer made between 90 days and one year before the �ling of the petition:(1) is avoided under section 547(b) of this title; and(2) was made for the bene�t of a creditor that at the time of such transfer was an

insider;the trustee may not recover under subsection (a) from a transferee that is not aninsider.

11 U.S.C. § 550(c).


1050

insiders.86 In Deprizio, the Seventh Circuit considered whetherand to what extent a transfer for the bene�t of an insider of thedebtor, but nonetheless to a non-insider, could be recovered as anavoidable preference. The debtor had made a payment to a lendermore than 90 days but less than one year prior to bankruptcy, onloans either guaranteed by insiders of the debtor or which weresecured by collateral in which the insiders had an interest.87 Thelender was not considered an insider.88 The Court held that thetrustee could recover the payment from the lender, even thoughthe lender was not an insider, because the transfer bene�ted theinsider.89 The Deprizio court further held that, pursuant to sec-tion 550(a), the trustee could recover either the transferred prop-erty or its value from either the lender as initial transferee or theguarantor, the insider “for whose bene�t such transfer wasmade.”

Section 550(c) was intended to solve the Deprizio problem. Itmakes clear that recovery of an avoidable transfer to an insidercannot be obtained from an initial transferee where the initialtransferee was not an insider, regardless of whether the transferultimately bene�ted an insider.90

While the addition of the language “or the entity for whosebene�t such transfer was made” to section 550(a)(1) in the 1984Amendments91 was intended to clarify that recovery can be soughtfrom an insider under such circumstances even though suchinsider is not a transferee for the purposes of section 550(a) ofthe Bankruptcy Code, section 550(c) clari�es that recovery forpreferential transfers cannot be sought from the non-insiderinitial transferee under such facts.92 However, this clari�cation is

86Levit v. Ingersoll Rand Financial Corp., 874 F.2d 1186, 19 Bankr. Ct.

Dec. (CRR) 574, 22 Collier Bankr. Cas. 2d (MB) 36, 11 Employee Bene�ts Cas.(BNA) 1323, Bankr. L. Rep. (CCH) P 72910 (7th Cir. 1989).

87Id. at 1187–88.

88Id. at 1198.

89Id. at 1200–01.

90See In re Exide Technologies, Inc., 299 B.R. 732, 746 (Bankr. D. Del.

2003) (holding that it is consistent with the legislative intent behind section550(c) to prohibit a trustee from recovering from a non-insider transferee); In reMid-South Auto Brokers, Inc., 290 B.R. 658, 662, 41 Bankr. Ct. Dec. (CRR) 22,49 Collier Bankr. Cas. 2d (MB) 1544 (Bankr. E.D. Ark. 2003) (same).

91See H. R. Rep. No. 103-835; 1994 U.S.C.C.A.N. 3340.

92See In re Exide Techs., Inc., 299 B.R. at 746; In re Mid-South Auto

Brokers, Inc., 290 B.R. at 662.


1051

still subject to debate, largely because Congress continued tomistake the distinction between avoidance and recovery.93

93Though intertwined, avoidance and recovery are two independent reme-

dies. Even absent recovery, other bene�ts may inure simply from avoidancedepending on the nature of the transfer avoided. In re Burns, 322 F.3d 421, 427,40 Bankr. Ct. Dec. (CRR) 282, 49 Collier Bankr. Cas. 2d (MB) 856, Bankr. L.Rep. (CCH) P 78813, 2003 Fed. App. 0071P (6th Cir. 2003) (avoidance legallynegates the transfer and, as the property was still in possession of the debtor,there was no need to invoke section 550 for recovery); In re Morgan, 276 B.R.785, 792 (Bankr. N.D. Ohio 2001) (when a non-possessory interest in property isavoided, there is nothing left to recover). The quintessential case is where thetransfer is a lien placed by a non-insider on property of the debtor's estate,securing an obligation of an insider. By avoiding the lien, the property is “freeand clear” of that interest even though no recovery from the non-insider lenderis possible. See In re Rosen Auto Leasing, Inc., 346 B.R. 798, 805–06, 46 Bankr.Ct. Dec. (CRR) 235 (B.A.P. 8th Cir. 2006) (lien on debtor's condominiumextinguished when not exchanged for value and labeled a fraudulent transfer tonon-insider lender); In re Williams, 234 B.R. 801, 803–05, 34 Bankr. Ct. Dec.(CRR) 600 (Bankr. D. Or. 1999). The avoidance/recovery distinction was featuredin several prominent cases in 2005. See In re Coleman, 426 F.3d 719, 726, 45Bankr. Ct. Dec. (CRR) 144, 54 Collier Bankr. Cas. 2d (MB) 1625, Bankr. L. Rep.(CCH) P 80377, 96 A.F.T.R.2d 2005-6641 (4th Cir. 2005) (holding that “theconcepts are intertwined to the extent that property cannot be recovered under§ 550 until an action is brought to avoid the transfer of that property . . . Butthe opposite is certainly not true . . .” when debtor avoided deeds of trust andno recovery was necessary as the “avoidance itself was the meaningful event”);In re International Administrative Services, Inc., 408 F.3d 689, 703, 44 Bankr.Ct. Dec. (CRR) 178, Bankr. L. Rep. (CCH) P 80279 (11th Cir. 2005) (noting thatthe “demarcation between avoidance and recovery is underscored by § 550(f),which places a separate statute of limitations on recovery actions”).

In BAPCPA, Congress again attempted a �x with respect to preferentialtransfers, this time in section 547(i), which reads:

If the trustee avoids under subsection (b) a transfer made between 90 days and 1year before the date of the �ling of the petition, by the debtor to an entity that is notan insider for the bene�t of a creditor that is an insider, such transfer shall beconsidered to be avoided under this section only with respect to the creditor that is aninsider.

11 U.S.C. § 547(i). Two possible problems with this �x exist. The �rst is thatsection 547(i) is limited on its face to transfers bene�ting insiders who arecreditors. While unlikely, it is possible that an insider bene�ting from suchtransfer may not also be a creditor. At least on its face, strict avoidance as op-posed to recovery would not give rise to creditor status under sections 502(h)and 101(10)(B) unless recovery—as opposed to avoidance—was sought againstthe insider/creditor, compare 11 U.S.C. § 101(10) (de�ning “creditor”) with 11U.S.C. § 101(31) (de�ning “insider”), in which case it appears that the problemof avoidance without transfer for the non-insider initial transferee may stillexist. When an estate is faced with a Deprizio transfer and a judgment-proofinsider, the result is a “catch-22.” In one of few decisions discussing section547(i), a bankruptcy court in Wisconsin considered whether a debtor's son whoguaranteed the debtor's loan was a creditor for purposes section 547(i) andfound that absent a waiver of contribution or indemni�cation rights in the


1052

Section 550(d) states that “[t]he trustee is entitled to only asingle satisfaction under subsection (a) of this section” and hasgenerated little but con�rming case law.94

One court has creatively used section 550(d) to prohibit atrustee from recovering from a bank that, without notice of thebankruptcy case, continued to sweep the debtor's bank accountsand make advances to the debtor postpetition.95 The district courtfound that while the strict requirements for recovery under sec-tion 550 had been met, the postpetition advances more than o�setthe sweeps, and therefore ruled that the trustee's attempt to re-cover was duplicative with the advances and prohibited undersection 550(d).96

Section 550(e) provides limited remedies for good faithtransferees from whom a transfer is avoided, namely a lien in theproperty recovered, to the extent of the lesser of the cost of anyimprovement the transferee makes in the transferred propertyand the increase in value of the property as a result of theimprovement.97 The statute clearly intends that this section only

guarantee, the son was considered a creditor. In re Halling, 449 B.R. 911,915–16 (Bankr. W.D. Wis. 2011).

94See In re Sherman, 67 F.3d 1348, 1358, 27 Bankr. Ct. Dec. (CRR) 1237,

34 Collier Bankr. Cas. 2d (MB) 655, Bankr. L. Rep. (CCH) P 76671 (8th Cir.1995) (double recovery prohibited); In re Skywalkers, Inc., 49 F.3d 546, 549, 26Bankr. Ct. Dec. (CRR) 1006, Bankr. L. Rep. (CCH) P 76394 (9th Cir. 1995)(duplicative recoveries inappropriate); In re Friedman's Inc., 394 B.R. 623,628–29 (S.D. Ga. 2008) (same); In re G-I Holdings, Inc., 2006 WL 1751793, *15(D.N.J. 2006) (same); In re Cybridge Corp., 312 B.R. 262, 268–69, 43 Bankr. Ct.Dec. (CRR) 81, 52 Collier Bankr. Cas. 2d (MB) 615 (D.N.J. 2004) (same); In reBean, 251 B.R. 196, 205 (E.D. N.Y. 2000), a�'d, 252 F.3d 113, 37 Bankr. Ct. Dec.(CRR) 268, Bankr. L. Rep. (CCH) P 78465 (2d Cir. 2001) (same); In re Bassett,221 B.R. 49, 55, 32 Bankr. Ct. Dec. (CRR) 820 (Bankr. D. Conn. 1998) (same);In re Armstrong, 217 B.R. 569, 579 (Bankr. E.D. Ark. 1998) (same); see also Inre Sawran, 359 B.R. 348 (Bankr. S.D. Fla. 2007) (trustee denied recovery wheredebtor transferred $20,000 to her father, who transferred it to third parties,who paid the debtor $12,000 prior to the bankruptcy because permittingrecovery would result in a windfall to the estate); In re Ames Dept. Stores, Inc.,161 B.R. 87, 91 (Bankr. S.D. N.Y. 1993) (debtor reimbursed for transfer, thus nodiminishment in estate and no recovery permitted). At least one court has heldthat damages are an appropriate remedy for fraudulent transfer under federallaw. See In re IVDS Interactive Acquisition Partners, 302 Fed. Appx. 574, 576–77(9th Cir. 2008) (partnership's founders were jointly and severally liable on arecovery action for funds fraudulently transferred from the partnership).

95In re Cybridge Corp., 312 B.R. 262, 43 Bankr. Ct. Dec. (CRR) 81, 52

Collier Bankr. Cas. 2d (MB) 615 (D.N.J. 2004).96

Id.97

Section 550(e) provides:


1053

protects good faith “initial” transferees. As noted above, onlyinitial transferees are strictly liable due to the operation of sec-tion 550(b) and therefore good faith subsequent transferees willnot need this section as they will not have their transfers avoided.Moreover, where a transfer is avoided under section 548 but notrecovered under section 550, the protections set forth in section550(e) do not apply.98

Finally, section 550(f) provides a statute of limitations forrecovery actions by stating that “[a]n action or proceeding under[section 550] may not be commenced after the earlier of (1) oneyear after the avoidance of the transfer on account of whichrecovery under this section is sought; or (2) the time the case isclosed or dismissed.”99 Section 550(f) is jurisdictional in nature,

(e)(1) A good faith transferee from whom the trustee may recover under subsec-tion (a) of this section has a lien on the property recovered to secure the lesser of:

(A) the cost, to such transferee, of any improvement made after the transfer,less the amount of any pro�t realized by or accruing to such transferee from suchproperty; and

(B) any increase in the value of such property as a result of such improvement,of the property transferred.(2) In this subsection, “improvement” includes:

(A) physical additions or changes to the property transferred;(B) repairs to such property;(C) payment of any tax on such property;(D) payment of any debt secured by a lien on such property that is superior or

equal to the rights of the trustee; and(E) preservation of such property.

11 U.S.C. § 550(e).98

In re Burns, 322 F.3d at 427, supra note 93 (when debtor transferred titleto property to third party but retained possession, the transfer was preservedfor the bene�t of the estate under section 551, no recovery after avoidance wasnecessary, and the protections of section 550 do not apply).

99See In re International Administrative Services, Inc., 408 F.3d 689, 703,

44 Bankr. Ct. Dec. (CRR) 178, Bankr. L. Rep. (CCH) P 80279 (11th Cir. 2005)(“The transaction must �rst be avoided before a plainti� can recover under 11U.S.C. § 550. . . This demarcation between avoidance and recovery is under-scored by § 550(f), which places a separate statute of limitations on recovery ac-tions; it provides that a suit for recovery must be commenced within one year ofthe time that the transaction is avoided or by the time the case is closed ordismissed, whichever occurs �rst”); see also In re Enron Corp., 343 B.R. 75, 80,46 Bankr. Ct. Dec. (CRR) 147, 56 Collier Bankr. Cas. 2d (MB) 195 (Bankr. S.D.N.Y. 2006), rev'd on other grounds and remanded, 388 B.R. 489 (S.D. N.Y. 2008)(“Section 546(a) sets forth the statute of limitations for an avoidance action andsection 550(f) sets forth the limitation period for a recovery”); see also In reMenk, 241 B.R. 896, 911, 43 Collier Bankr. Cas. 2d (MB) 336 (B.A.P. 9th Cir.1999) (closing of a bankruptcy case terminates many of the trustee's avoidingand recovery powers).


1054

and is not waived by the defendant's failure to timely plead.100

Note that the time frame runs from the date the transfer wasavoided, not the date of the transfer.101

III. CASE LAW DEVELOPMENTS IN 2011This section summarizes and analyzes certain decisions issued

in 2011 addressing portions of sections 548 and/or 550 of theBankruptcy Code that the author believes to be of import andgeneral interest to bankruptcy practitioners. This section is not acomplete analysis of the issues discussed or the case law regard-ing the same, but rather is intended to provide the reader with aselected sampling of interesting issues which courts haveconsidered during the past year.

A. TOUSA—Heightened Standards for Lenders AcceptingRepayment

In February 2011, the United States District Court for theSouthern District of Florida in an appeal from an avoidance ac-tion in the case of In re TOUSA, Inc.102 reversed and quashed theportions of a controversial 2009 bankruptcy court decision (a)�nding that liens granted in connection with loans whoseproceeds were used to pay former lenders were constructivelyfraudulent and (b) ordering disgorgement of those proceeds.103

100In re Sandoval, 470 B.R. 195, 200 (Bankr. D. N.M. 2012); In re Phimma-

sone, 249 B.R. 681, 683, 44 Collier Bankr. Cas. 2d (MB) 890 (Bankr. W.D. Va.2000).

101In re Enron Corp., 343 B.R. at 80 (the limitations period starts to run

once the trustee avoids the transfer sought to be recovered); In re Serrato, 233B.R. 833, 835, 41 Collier Bankr. Cas. 2d (MB) 1461 (Bankr. N.D. Cal. 1999).

102TOUSA II, 444 B.R. at 613.

103Id. at 680. On March 22, 2012, the United States Bankruptcy Court for

the Southern District of Florida approved a partial settlement among theConveying Subsidiaries (de�ned herein), the Committee (de�ned herein) andcertain of the Transeastern Lenders (de�ned herein) that provides a �oor andceiling for recovery from the settling Transeastern Lenders and relieves thoselenders of certain bonding requirements. However, this partial settlementcontemplated that the appeal to the Eleventh Circuit would continue and thusdid not resolve the merits of the Committee's appeal of the district court deci-sion, discussed herein, and the Committee's pursuit of recovery from the non-settling Transeastern Lenders. See Order Approving Settlement AgreementAmong the Committee, the Conveying Subsidiaries, Monarch AlternativeCapital LP, as Investment Advisor to Monarch Master Funding Ltd, JPMorganChase Bank, N.A., and Bear Stearns Investment Products Inc., In re TOUSA,Inc., No. 08-10928 (March 22, 2012).


1055

The bankruptcy court104 had held that liens granted and obliga-tions incurred by the parent's subsidiaries in exchange for a newloan used to make payments to settle litigation involving only theparent and other subsidiaries were not in exchange for reason-ably equivalent value and ordered, inter alia, disgorgement bythe lenders who received the proceeds. As a result, even thoughthe district court addressed only the appeals of the recipients ofthe loan proceeds, the opinion was highly anticipated and rankedas one of the most discussed bankruptcy decisions of 2011.105 OnMay 15, 2012, in a subsequent appeal, the United States Court ofAppeals for the Eleventh Circuit reversed the district court's de-cision, a�rmed the decision of the bankruptcy court andremanded to the district court for consideration the issues ofjudicial assignment, consolidation and remedies.106

1. Factual BackgroundTOUSA, Inc. (“TOUSA”) and its subsidiaries designed, built

and marketed residential real estate developments in the Floridaregion.107 Prior to the transactions at issue, TOUSA's businesswas �nanced through over $1 billion of unsecured bond debt (the“Bonds”), with TOUSA as the primary obligor on the Bonds, andits subsidiaries jointly and severally liable as guarantors.108

TOUSA was also the borrower under a secured revolving loan fa-cility (the “Revolver”), and several of its subsidiaries acted asguarantors of TOUSA's obligations under the Revolver.109 Aswould become crucial at trial, both the indentures governing theBonds and the agreements governing the Revolver contained pro-visions (the “Trigger Clauses”) specifying that any judgment over

104TOUSA I, 422 B.R. at 783. The TOUSA I decision was discussed in the

2010 edition of this article. See Sheikh, supra note 3. The district court inTOUSA II cited to the 2010 edition of this article. TOUSA II, 444 B.R. at 676.

105The appeals of TOUSA I were not consolidated. TOUSA II addressed only

the appeals of one group of lenders to a failed joint venture to which TOUSAwas a partner, in which lenders received the proceeds of the new loan madepursuant to a settlement resolving litigation that did not involve the subsidiar-ies of TOUSA. The remaining appeals of TOUSA I were stayed pending theCommittee's (herein de�ned) appeal of TOUSA II to the Eleventh Circuit Courtof Appeals. See Order Staying and Administratively Closing Case, Wells FargoBank, NA v. O�cial Comm. of Unsecured Creditors, No. 10-cv-60018 (S.D. Fla.March 28, 2011).

106In re TOUSA, Inc., 680 F.3d 1298, 1316, 56 Bankr. Ct. Dec. (CRR) 135

(11th Cir. 2012).107

TOUSA II, 444 B.R. at 620.108

Id. at 622–23.109

Id. at 625–26, 638.


1056

$10 million involving TOUSA or any of its subsidiaries wouldconstitute an event of default, making all outstanding amounts ofprincipal and interest on the Bonds and Revolver immediatelydue and payable.110 Such a default would likely have led to bank-ruptcy �lings by TOUSA and its subsidiaries.111

a. The Joint Venture Litigation and SettlementIn 2007, due to the failure of a joint venture involving TOUSA,

certain of TOUSA's subsidiaries, and a third party, TOUSAbecame enmeshed in litigation with the lenders to the jointventure (the “Transeastern Lenders”).112 In light of the TriggerClauses, and because TOUSA's principals predicted that anadverse judgment over $10 million was extremely likely,113

TOUSA entered into a settlement agreement with the Transeast-ern Lenders (the “Settlement”) whereby TOUSA agreed to paythe Transeastern Lenders approximately $421 million.114 To�nance the Settlement, TOUSA and its subsidiaries borrowed ap-proximately $500 million in new secured debt (the “New Loan”),even though the subsidiaries were not liable for the joint ventureindebtedness, were not party to the ensuing litigation andreceived none of the proceeds of the New Loan, as the proceedswere earmarked speci�cally to fund the Settlement.115 TOUSAand its subsidiaries (the “Conveying Subsidiaries”) were requiredto pledge their assets to the New Loan lenders (the “New Lend-ers”) as security for the New Loan.116 In order to ensure that theNew Lenders' liens ranked equal in priority to the pre-existingliens of the Revolver lenders, the Conveying Subsidiaries securedthe Revolver lenders' consent.117

As part of the Settlement, TOUSA received assets and several

110Id. at 622–23, 625–26.

111Id. at 632.

112Id. at 630. TOUSA was a co-borrower with the other joint venture party

on the loans provided by the Transeastern Lenders to the joint venture.113

In TOUSA II, the district court quoted from testimony, noting that“TOUSA management believed that ‘the senior lenders [to the Senior CreditAgreement] were entitled to get 100 percent cash. Everyone took the position ifwe didn't pay them 100 percent, we had no deal . . . Certainly, we had a seriesof advisors, and the decision was that there was no sense spending time tryingto negotiate with them.’ ” Id. at 632 (citations omitted).

114Id. at 633.

115Id. at 634.

116The Conveying Subsidiaries also provided guaranties for the obligations

under the New Loan. Id. at 634–35.117

Id.


1057

properties owned by the joint venture, the deposits previouslyheld by the joint venture, and the proceeds of sold assets whichwere available to all TOUSA entities, including the ConveyingSubsidiaries.118 The acquisition of these assets increased the bor-rowing base on the Revolver by approximately $150 million, againto the bene�t of all TOUSA entities, including the ConveyingSubsidiaries.119 The o�cers and directors of TOUSA and theConveying Subsidiaries executed formal resolutions or consentsapproving the companies' obligations under the New Loan, allcontaining language recognizing that the acquisition of the newdebt was in the “best interest” and for the “bene�t” of TOUSAand the Conveying Subsidiaries.120 Further, the Settlement cre-ated approximately $74.8 million in future tax bene�ts forTOUSA and the Conveying Subsidiaries.121 Although TOUSA'smanagement intended for the Settlement to prevent the enter-prise's bankruptcy, the sharp decline of the real estate marketand other factors led TOUSA and most of its subsidiaries to �lefor bankruptcy protection on January 29, 2008, less than sixmonths after the Settlement.122

b. The Avoidance Actions Attacking the SettlementIn July 2008, the o�cial committee of unsecured creditors ap-

pointed in the bankruptcy cases (the “Committee”) commencedadversary proceedings seeking to avoid as constructively fraudu-lent transfers the liens and guaranties conveyed to the New Lend-ers by the Conveying Subsidiaries and to recover the proceeds ofthe New Loan paid to the Transeastern Lenders.123 Among otherthings, the Committee argued that the Conveying Subsidiarieswere either insolvent at the time of the transfers related to theNew Loan and the Settlement or were made insolvent by thosetransfers and did not receive reasonably equivalent value whenthey pledged their assets to the New Lenders in return for theNew Loan, the proceeds of which were used to satisfy TOUSA'sobligations to the Transeastern Lenders in a litigation to whichthe Conveying Subsidiaries were not parties.124

118Id. at 633.

119Id.

120Id. at 635.

121Id. at 636.

122Id. at 637.

123Id.

124TOUSA I, 422 B.R. at 786.


1058

2. TOUSA I—Transfers Related to New Loan FoundConstructively FraudulentAfter a lengthy trial, the bankruptcy court ruled in favor of the

Committee, ordering the avoidance of the liens and obligationsgranted to the New Lenders as constructively fraudulenttransfers pursuant to section 548(a)(1)(B) of the Bankruptcy Codeand the disgorgement from the Transeastern Lenders of theproceeds of the New Loan they received in the Settlement.125 Thebankruptcy court found that the obligations incurred and theliens granted by the Conveying Subsidiaries, as well as the pay-ments made to the Transeastern Lenders, were avoidable becausethe Conveying Subsidiaries did not receive reasonably equivalentvalue in exchange for their transfers.126 The bankruptcy courtheld that the Conveying Subsidiaries received “no direct value”and, if they received “any value at all, it was minimal and did notcome anywhere near the millions of dollars of obligations theyincurred.”127 In so holding, the bankruptcy court explicitly rejectedthe Transeastern Lenders' argument that the value they providedincluded that the New Loan prevented the immediate bankrupt-cies of TOUSA and its subsidiaries, stating that the ConveyingSubsidiaries received “minimal indirect bene�ts” because the“[t]ransaction did not in fact prevent the bankruptcy of the par-ent company” and because “the Conveying Subsidiaries wouldnot have been seriously harmed by such an earlier bankruptcy.”128

In addressing the Transeastern Lenders' argument that a judg-ment against TOUSA in the joint venture litigation would havecaused a default under the Revolver that would have certainlyled to the Conveying Subsidiaries' bankruptcies, the bankruptcycourt held that there was “no reason to believe that the Convey-ing Subsidiaries could not have dealt with a possible Revolver

125Id. at 843–44, 883–86. The bankruptcy court, in so �nding, concluded

that the Conveying Subsidiaries received less than reasonably equivalent valuefor the obligations they incurred, and: (i) were insolvent both before and afterthe transaction; (ii) were left with unreasonably small capital with which tocontinue operations after the transaction; and (iii) incurred debts that went be-yond their ability to pay as such debts matured as a result of the transaction.Id. at 858–69. See section II.A. of this article for the language of section 548(a)of the Bankruptcy Code.

126TOUSA I, 422 B.R. at 858–69, 872–75.

127Id. at 844.

128Id. at 846. Although not an issue in TOUSA II, the bankruptcy court

found that certain “savings clauses” in the loan documents, which were intendedto protect the lenders from fraudulent transfer claims, were invalid. Id. at 863–64.


1059

default by transitioning to an alternative source of �nancing.”129

The bankruptcy court made this �nding despite undisputedtestimony from TOUSA's management that no alternative �nanc-ing was available to the Conveying Subsidiaries.130

The bankruptcy court also held that the New Lenders and theTranseastern Lenders did not act in “good faith” for purposes ofshielding avoidance and/or liability under the a�rmative defen-ses of sections 548(c) and 550(b) of the Bankruptcy Code.131 Thebankruptcy court found that the New Lenders and TranseasternLenders were, respectively, grossly negligent when they fundedthe New Loan and accepted the proceeds of the New Loan,because at the time of the transfers there existed “overwhelmingevidence that TOUSA was �nancially distressed.”132 The bank-ruptcy court determined that the New Lenders and the Transeast-ern Lenders had a duty to investigate the �nancial condition ofTOUSA and the Conveying Subsidiaries, and that, based uponavailable information, they knew or should have known thatTOUSA and the Conveying Subsidiaries either were or were closeto becoming insolvent at the time of the Settlement.133

3. TOUSA II—Reversal of All Rulings Related toTranseastern LendersBoth the Transeastern Lenders and the New Lenders ap-

pealed134 the bankruptcy court's factual �ndings and legal conclu-sions135 and, in TOUSA II, the district court reversed the bank-ruptcy court's decision on every major issue with respect to the

129TOUSA II, 444 B.R. at 641 (citing TOUSA I, 422 B.R. at 847).

130Id. at 633.

131TOUSA I, 422 B.R. at 869 (�nding New Lenders did not act in good faith

for purposes of section 548(c)); id. at 877 (�nding Transeastern Lenders did notact in good faith for purposes of section 548(c)); id. at 875–76 (TranseasternLenders not entitled to rely on the section 550(b) good faith defense becausethey had not acted in good faith).

132Id. at 850–55.

133Id.

134The appeals were split between two judges, with Judge Alan Gold

handling the appeals of the Transeastern Lenders and Judge Adalberto Jordanhandling the appeals of the New Lenders. Following the TOUSA II decision, theNew Lenders' appeals were stayed pending a determination by the EleventhCircuit Court of Appeals. See Order Staying and Administratively Closing Case,Wells Fargo Bank, NA v. O�cial Committee of Unsecured Creditors, No. 10-cv-60018 (S.D. Fla. March 28, 2011).

135The district court conducted a de novo review of the bankruptcy court's

legal determinations and applies a “clearly erroneous” standard of review to thebankruptcy court's �ndings of fact. TOUSA II, 444 B.R. at 643 (citing In re


1060

Transeastern Lenders.136 In a lengthy and scathing opinion, thedistrict court took a highly unusual step when, rather thanremanding the case to the bankruptcy court, it simply quashed137

the bankruptcy court's substantive rulings.

a. Reasonably Equivalent ValueA central issue in the Transeastern Lenders' appeal to the

district court was the question of whether, for purposes of section548(a)(1)(B) of the Bankruptcy Code, the Conveying Subsidiariesreceived “reasonably equivalent value”138 in exchange for theirliens and obligations to the New Lenders as well as for thetransfers of proceeds to the Transeastern Lenders.139 The districtcourt ruled that the bankruptcy court's holdings in this regardwere clearly erroneous.140 While the bankruptcy court rejected

Trusted Net Media Holdings, LLC, 550 F.3d 1035, 1038 n.2, 50 Bankr. Ct. Dec.(CRR) 254, 61 Collier Bankr. Cas. 2d (MB) 292, Bankr. L. Rep. (CCH) P 81366(11th Cir. 2008)). The court in TOUSA II noted that the “clearly erroneous”standard would be relaxed because the bankruptcy court's order was “practi-cally a verbatim adoption of the Committee's Proposed Findings of Fact andConclusions of Law submitted after the trial . . . Of the Committee's 448proposed �ndings and conclusions, the bankruptcy court adopted 446 in wholeor in part, while adopting none of the defendants' over 1,600 proposed �ndings.”Id. at 643–44 (emphasis supplied).

136Id. at 643. The following two questions were presented by the Transeast-

ern Lenders: (i) “Whether the Transeastern Lenders can be compelled todisgorge to the Conveying Subsidiaries funds paid by TOUSA to satisfy a legiti-mate uncontested debt, where the Conveying Subsidiaries did not control thetransferred funds”; and (ii) “Whether the Transeastern Lenders are liable fordisgorgement as the entities ‘for whose bene�t’ the Conveying Subsidiariestransferred the Liens to the New Lenders, where the Transeastern Lendersreceived no direct and immediate bene�t from the Lien Transfer.” Id. at 642.

137The TOUSA II court noted that where “the factual record allows but one

‘resolution of the factual issue,’ remand is unnecessary.” Id. at 645 (quotingPullman-Standard v. Swint, 456 U.S. 273, 292, 102 S. Ct. 1781, 72 L. Ed. 2d 66,28 Fair Empl. Prac. Cas. (BNA) 1073, 28 Empl. Prac. Dec. (CCH) P 32619, 33Fed. R. Serv. 2d 1501 (1982)); see also Jessica D. Gabel, The Terrible Tousas:Opinions Test the Patience of Corporate Lending Practices, 27 Emory Bankr.Dev. J. 415, 427 (2011) (“A review of bankruptcy appeals reveals fewer than �vereported decisions where an order was quashed. The more common and perhapsmore defensible on appeal approach is to remand the case to the bankruptcycourt.”).

138“‘[T]he burden of proving lack of reasonably equivalent value . . . rests

on the trustee challenging the transfer,’ ” even in the context of an indirectvalue analysis. TOUSA II, 444 B.R. at 649–650 (citations omitted).

139There was no dispute that the Transeastern Lenders were owed the

amounts paid pursuant to the Settlement. Id. at 645.140

Id. at 667.


1061

the Transeastern Lenders' argument that the Conveying Subsid-iaries' potential opportunity to avoid bankruptcy as a result ofthe Settlement constituted value, the district court found it to bemeritorious, holding that “indirect, intangible, economic bene�ts,including the opportunity to avoid default, to facilitate theenterprise's rehabilitation, and to avoid bankruptcy, even if itprovided to be short lived, may be considered in determining rea-sonably equivalent value. An expectation, such as in this case,that a settlement which would avoid default and produce a strongsynergy for the enterprise, would su�ce to confer ‘value’ so longas that expectation was legitimate and reasonable.”141 The districtcourt opined that the bankruptcy court's ruling was “contrary towell-established law which holds that indirect bene�ts may takemany forms, both tangible and intangible”142 and went on to state:“[w]hat is key in determining reasonable equivalency then iswhether, in exchange for the transfer, the debtor received inreturn the continued opportunity to �nancially survive, where,without the transfer, its �nancial demise would have been all butcertain. Where such indirect economic bene�ts are provided, ‘thedebtors’ net worth has been preserved, and the interests of thecreditors will not have been injured by the transfer.’ ”143 Thedistrict court further rejected as “a per se rule . . . that indirectbene�ts must be mathematically quanti�ed,”144 stating that “[a]debtor's opportunity . . . to improve its prospects of avoidingbankruptcy are precisely the kind of bene�ts that, by de�nition,are not susceptible to exact quanti�cation but are nonethelesslegally cognizable under section 548.”145

The district court criticized the bankruptcy court for its retro-spective analysis of reasonably equivalent value, which empha-sized that TOUSA's and the Conveying Subsidiaries' bankruptcy�lings took place a mere six months after the Settlement and re-lated transactions. It warned against the hindsight review oftransactions “through the lens of retrospection to point out thatbankruptcy ultimately was not avoided . . . [W]hether a debtor

141Id. at 660.

142Id. at 656.

143Id. at 660–61 (quoting Kipperman v. Onex Corp., 411 B.R. 805, 809 (N.D.

Ga. 2009), reconsideration denied in part, 2010 WL 761227 (N.D. Ga. 2010)).144

Id. at 665.145

Id.


1062

received reasonably equivalent value must be evaluated as of thedate of the transaction.”146

i. The District Court found the Bankruptcy Court Nar-rowed the Meaning of Value in the Context of ReasonablyEquivalent Value

The district court reversed the bankruptcy court's �ndings onthe meaning of “value” in the context of determining “reasonablyequivalent value.”147 Although the Bankruptcy Code does notde�ne “reasonably equivalent value,” it does de�ne “value,” forfraudulent transfer purposes, as “property, or satisfaction orsecuring of a present or antecedent debt of the debtor.”148 Thedistrict court found that the bankruptcy court committed “com-pelling legal error” when it (a) relied on the dictionary de�nitionof “property” to analyze whether the Conveying Subsidiaries hadreceived value, and (b) concluded that the avoidance of default orbankruptcy did not satisfy the de�nition of “property,”149 andtherefore could not constitute value.150 The district court observedthat the bankruptcy court's ruling was contrary to established

146Id. at 666 (citing In re Joy Recovery Technology Corp., 286 B.R. 54, 75

(Bankr. N.D. Ill. 2002)). TOUSA II also cited In re R.M.L., Inc., 92 F.3d 139,152, 29 Bankr. Ct. Dec. (CRR) 591, 36 Collier Bankr. Cas. 2d (MB) 498 (3d Cir.1996) (viewing a transaction in hindsight would mean that only successfulinvestments can confer value to a debtor, contrary to one policy reason behind§ 548, which is to encourage the debtor to take “some risks that could generatevalue”).

147TOUSA II, 444 B.R. at 655.

148Id. (citing 11 U.S.C. § 548(d)(2)(A)).

149The district court posited that the bankruptcy court's use of the dictio-

nary de�nition of “property” was contrary even to the term's intended meaningin the Bankruptcy Code, citing legislative history that indicates that “property”should be construed in the broadest sense. It further cited Supreme Court pre-cedent holding that “property” is broadly and generously de�ned. Id. at 656 (cit-ing Segal v. Rochelle, 382 U.S. 375, 379, 86 S. Ct. 511, 15 L. Ed. 2d 428, 66-1U.S. Tax Cas. (CCH) P 9173, 17 A.F.T.R.2d 163 (1966); Kokoszka v. Belford, 417U.S. 642, 94 S. Ct. 2431, 41 L. Ed. 2d 374, 74-2 U.S. Tax Cas. (CCH) P 9570, 34A.F.T.R.2d 74-5196 (1974); Perry v. Sindermann, 408 U.S. 593, 601 (1972)(‘‘ ‘[P]roperty’ denotes a broad range of interests that are secured by ‘existingrules or understandings.’ ”)); see also Lines v. Frederick, 400 U.S. 18, 19, 91 S.Ct. 113, 27 L. Ed. 2d 124 (1970) (same); In re Taylor, 386 B.R. 361, 368, 59Collier Bankr. Cas. 2d (MB) 1267, 101 A.F.T.R.2d 2008-2332 (Bankr. S.D. Fla.2008), a�'d, 402 B.R. 56, 103 A.F.T.R.2d 2009-477 (S.D. Fla. 2008) (citing Segaland noting that “[s]ubsequent Court of Appeals decisions have con�rmed thecontinuing vitality of Segal under the Bankruptcy Code”).

150TOUSA II, 444 B.R. at 656. The district court noted that a bankruptcy

court's de�nition of a Bankruptcy Code term is subject to de novo review, citing


1063

precedent recognizing that “property” is to be construed broadlyand encompasses tangibles and intangibles, as well as indirectbene�ts, including economic bene�ts.151

The district court found that the bankruptcy court further erredin failing to consider the “totality of the circumstances” inmeasuring the reasonable equivalency of the alleged valueprovided to the Conveying Subsidiaries.152 It opined, based on theEleventh Circuit's holding in In re Duque Rodriguez,153 that “thedecisive inquiry can be simpli�ed to whether, based on the total-ity of the circumstances at the time of the transfer, the resultwas to preserve the debtor's net worth by conferring realizablecommercial value on the debtor. Otherwise stated, but for thetransfer, was there a realistic risk that the Conveying Subsidiar-ies and the enterprise would not �nancially continue to sur-vive?”154 Taking into account the Trigger Clauses and the likelydevastating e�ect an adverse judgment would have on theConveying Subsidiaries' �nancial health and survival, the districtcourt found that the Conveying Subsidiaries did receive reason-ably equivalent value under the “totality of the circumstances”test.155

In reviewing the bankruptcy court's dismissal of the Transeast-ern Lenders' argument that the Conveying Subsidiaries hadreceived reasonably equivalent value in exchange for any minimal

In re Morgan, 182 F.3d 775, 777, 34 Bankr. Ct. Dec. (CRR) 973, Bankr. L. Rep.(CCH) P 77959, 84 A.F.T.R.2d 99-5475 (11th Cir. 1999).

151TOUSA II, 444 B.R at 656–57.

152Id. at 661. The district court examined the “totality of the circumstances”

test adopted by the Third Circuit Court of Appeals in R.M.L. and applied in theEleventh Circuit by district and bankruptcy courts in Florida. The R.M.L. testconsiders three factors: (i) whether the transaction was at arm's length; (ii)whether the transferee acted in good faith; and (iii) the degree of the di�erencebetween the fair market value of the assets transferred and the price paid. In reR.M.L., Inc., 92 F.3d 139, 152, 29 Bankr. Ct. Dec. (CRR) 591, 36 Collier Bankr.Cas. 2d (MB) 498 (3d Cir. 1996); see also Wiand v. Waxenberg, 611 F. Supp. 2d1299 (M.D. Fla. 2009); In re Evergreen Security, Ltd., 319 B.R. 245, 253 (Bankr.M.D. Fla. 2003).

153In re Rodriguez, 895 F.2d 725, 727, 22 Collier Bankr. Cas. 2d (MB) 633,

Bankr. L. Rep. (CCH) P 73282 (11th Cir. 1990) (holding that payments thatprovided neither direct nor indirect bene�t to debtor were avoidable as fraudu-lent transfers).

154TOUSA II, 444 B.R. at 662.

155Id. at 663–65.


1064

interest156 they may have had in the proceeds of the New Loan,the district court analyzed the metrics of reasonably equivalentvalue employed by the bankruptcy court.157 The district courtdiscussed the error implicit in the bankruptcy court's simultane-ous holdings that (a) although the Conveying Subsidiaries had aminimal property interest in the New Loan proceeds su�cient tomake it over the hurdle of section 548's “interest of the debtor inproperty” requirement, (b) they did not receive reasonably equiv-alent value because any minimal value received by the Convey-ing Subsidiaries was not equivalent to the value of the pledgesmade to secure the $500 million New Loan.158 Logically, thedistrict court reasoned, if the Conveying Subsidiaries had aminimal property interest in the New Loan proceeds, then they,in turn, would only have had to receive a minimal bene�t inexchange to constitute reasonably equivalent value, because “rea-sonably equivalent value must be measured in terms of the valueof the debtors' interest in the property conveyed.”159 Thus, thedistrict court found that such value had been provided.160

ii. Indirect and Intangible Bene�tsThe district held that the bankruptcy court's determination

that the indirect bene�t received by the Conveying Subsidiaries

156While disregarded in TOUSA II, the Transeastern Lenders argued below

that the Conveying Subsidiaries and TOUSA were so related such that theyshared an identity of interest su�cient to establish that, when value was givento TOUSA, value was also given to the Conveying Subsidiaries and, as such, theConveying Subsidiaries received reasonably equivalent value through the NewLoan. Id. at 670. The “identity of interest” doctrine recognizes that where thedebtor and a third party are so related that the two share an “identity of inter-est,” then a transaction that bene�ts one party will necessarily inure to the ben-e�t of the other. Id. at 653–54 n. 43 (quoting In re Royal Crown Bottlers ofNorth Alabama, Inc., 23 B.R. 28, 30 (Bankr. N.D. Ala. 1982)). The district court,however, did not reach the “identity of interest” issue, because it held that therecord below established that the Conveying Subsidiaries received an indirecteconomic bene�t, and therefore there was no need to address whether the bene-�t to TOUSA was shared by the Conveying Subsidiaries. Id. at 654. In so �nd-ing, the district court accepted the bankruptcy court's conclusion that, in orderto demonstrate reasonably equivalent value, bene�ts must be received by eachdebtor. Id.

157Id. at 651.

158Id.

159Id. (emphasis supplied) (citing In re Duke & Benedict, Inc., 265 B.R. 524,

531 (Bankr. S.D. N.Y. 2001) (noting that the relevant inquiry for analyzing rea-sonably equivalent value is not “the value of the property that was conveyed,but the value of the debtor's interest in the property conveyed”)).

160Id. at 653.


1065

had little or no value was also clearly erroneous,161 and foundthat the bankruptcy court had impermissibly shifted the burdenof proof for a lack of reasonably equivalent value under section548(a)(1)(B)(i) from the Committee to the defendants when itfound that the New Lenders and the Transeastern Lenders had“failed to carry the burden of producing evidence of indirectbene�ts that were tangible and concrete, and quantifying thevalue of those bene�ts with reasonable precision.”162 It furtherchastised the bankruptcy court for ignoring well-established pre-cedent holding that indirect value includes both tangible andintangible bene�ts.163 In �nding that the Conveying Subsidiarieshad not received reasonably equivalent value, the bankruptcycourt stated that “value” under section 548 of the BankruptcyCode does not include “bene�ts,” direct or indirect, and deter-mined that any purported indirect value provided by thedefendants was legally irrelevant.164 Citing precedent from theSupreme Court and other circuit courts, the district courtemphasized that economic bene�ts, including indirect bene�ts,may be considered in assessing value.165 Further, the districtcourt found that the bankruptcy court ignored Eleventh Circuitprecedent holding that section 548(a)(1) “does not authorize void-ing a transfer which confers an economic bene�t upon the debtor,

161Id. at 667–70.

162Id. at 653.

163Id. at 657.

164TOUSA I, 422 B.R. at 868.

165TOUSA II, 444 B.R. at 657 (citing In re Hannover Corp., 310 F.3d at 801

(“holding that the ‘arc of § 548 easily encompasses as ‘value’ an exchange ofcash for a right to buy or sell property at a future point in time’ ”); In re Young,82 F.3d 1407, 1415, 36 Collier Bankr. Cas. 2d (MB) 163 (8th Cir. 1996); (“hold-ing that the district court correctly ‘did not de�ne ‘value’ only in terms oftangible property or marketable �nancial value’ ”) Cordes & Co., LLC v. Mitch-ell Companies, LLC, 605 F. Supp. 2d 1015, 1022 (N.D. Ill. 2009) (‘‘ ‘Indirectbene�ts can include a wide range of intangibles.’ ”); In re Jumer's Castle Lodge,Inc., 338 B.R. 344, 354, Bankr. L. Rep. (CCH) P 80469 (C.D. Ill. 2006), a�'d, 472F.3d 943, 47 Bankr. Ct. Dec. (CRR) 146, Bankr. L. Rep. (CCH) P 80830 (7th Cir.2007) (‘‘ ‘[I]ndirect bene�ts constitute ‘value’ and can include a wide range ofintangibles such as: corporation's goodwill or increased ability to borrow work-ing capital; the general relationship between a�liates or ‘synergy’ within acorporate group as a whole; and a corporation's ability to retain an importantsource of supply or an important customer’ ”)).


1066

either directly or indirectly,”166 and noted that the EleventhCircuit's ruling in In re Duque Rodriguez recognized that adebtor's reprieve from foreclosure, which allowed the debtor tocontinue as a going concern, could be considered an indirect eco-nomic bene�t and, thus, “value” under section 548 of the Bank-ruptcy Code.167

b. Ordering Recovery from the Transeastern LendersUnder Section 550(a)(1) of the Bankruptcy Code

In ordering disgorgement of the proceeds of the New Loan, thebankruptcy court in held that the Transeastern Lenders, as theultimate bene�ciaries of the liens granted by the Conveying Sub-sidiaries, were liable under section 550(a)(1) of the BankruptcyCode168 as both (i) direct transferees of the New Loan proceeds169

and (ii) entities “for whose bene�t” the Conveying Subsidiariestransferred the liens to the New Lenders.170 The district court re-versed these holdings.

i. Whether the Transeastern Lenders Were DirectTransferees

The Transeastern Lenders argued that the “direct transfer”theory of liability employed by the bankruptcy court was �awedbecause avoidance under section 548 of the Bankruptcy Code, thepredicate for recovery under section 550(a) of the BankruptcyCode, is based upon “a transfer of an interest of the debtor inproperty.” They maintained that such a transfer did not occurwhen the Transeastern Lenders received the New Loan proceeds

166TOUSA II, 444 B.R. at 657 (quoting In re Rodriguez, 895 F.2d 725, 727,

22 Collier Bankr. Cas. 2d (MB) 633, Bankr. L. Rep. (CCH) P 73282 (11th Cir.1990)).

167Id. at 658. The debtor in In re Duque Rodriguez made payments on a

subsidiary's aircraft loan. The Eleventh Circuit, in avoiding the transfers, foundthat the debtor did not bene�t, either directly or indirectly, from such pay-ments. 895 F.2d at 729.

168Section 550(a) of the Bankruptcy Code, in relevant part, provides: “Except

as otherwise provided in this section, to the extent that a transfer is avoidedunder section 544, 545, 547, 548, 549, 553(b) or 724(a) . . ., the trustee may re-cover, for the bene�t of the estate, the property transferred, or, if the court soorders, the value of such property, from: (1) the initial transferee of such transferor the entity for whose bene�t such transfer was made; or (2) any immediate ormediate transferee of such initial transferee.” 11 U.S.C. § 550(a); see sectionII.B. of this article for a general description of section 550(a) of the BankruptcyCode and its background.

169TOUSA II, 444 B.R. at 645.

170Id.; see also TOUSA I, 422 B.R. at 870, 881, 884.


1067

because the Conveying Subsidiaries did not have a property inter-est in the proceeds and thus transferred nothing to the Transeast-ern Lenders.171 The district court agreed, noting that in order tohave an “interest in property,” a debtor must actually havecontrol over the property.172 Since the agreements governing theNew Loan required that the proceeds be immediately used to paythe Settlement amount to the Transeastern Lenders, the Convey-ing Subsidiaries never had possession of or control over the funds,nor the ability to direct how the funds should be used. Thus,since the Conveying Subsidiaries did not have a property interestin the New Loan proceeds, the district court held that the transferof proceeds was not avoidable under a “direct transfer” theory.173

ii. The District Court Found the Transfers Subject toAvoidance Were Not for the Bene�t of the TranseasternLenders

The bankruptcy court also held that the Transeastern Lenderswere liable under section 550(a) of the Bankruptcy Code as enti-ties “for whose bene�t” the Conveying Subsidiaries transferredliens to the New Lenders because the liens collateralized theNew Loan, the proceeds of which were used to satisfy TOUSA'sdebt to the Transeastern Lenders.174 The district court, however,rejected this ruling,175 and held that the Transeastern Lenderswere not entities from whom the transfer could be recoveredbecause the Transeastern Lenders did not receive the liens, onlythe New Loan proceeds.176 Further, the district court clari�edthat recovery from the Transeastern Lenders was inappropriatebecause the transfer of the New Loan proceeds was not a direct

171TOUSA II, 444 B.R. at 646; see also 11 U.S.C. § 548(a)(1).

172TOUSA II, 444 B.R. at 646–48 (citing In re Chase & Sanborn Corp., 848

F.2d 1196, 1199, Bankr. L. Rep. (CCH) P 72363 (11th Cir. 1988) and In reChase & Sanborn Corp., 813 F.2d 1177, 1181–82, Bankr. L. Rep. (CCH) P 71753(11th Cir. 1987)). The district court later found that the initial transfer avoidedfor purposes of section 550 was the transfer of the liens to the New Lenders,who had complete control over those liens. Id. at 672.

173Id. at 646–48. This de�nition of property may be narrower than the de�-

nition relied upon by the district court to �nd that the Transeastern Lendershad provided “reasonably equivalent value.” See supra at note 149.

174TOUSA II, 444 B.R. at 670.

175Notably, the district court cited the 2010 edition of this article, observing

that section 550(a)(1) did not initially embody the ability to recover from theentity for whose bene�t such transfer was made. See id. at 676.

176Id. at 672. The district court was careful to parse the trial testimony to

determine exactly which transfer was at issue with respect to § 550(a)(1) of theBankruptcy Code’s “such transfer” language, determining that the relevant


1068

consequence of the transfer of liens to the New Lenders.177 Thedistrict court took care to visit this issue, even as it acknowledgedthat its decision on this issue was unnecessary in light of itsother rulings on reasonably equivalent value and related issues.178

The district court found that the bankruptcy court's interpreta-tion of section 550(a)(1)'s “for whose bene�t such transfer wasmade” language (a) was “overly broad” and (b) neglected toanalyze the speci�c text of the provision.179 Put simply, section550(a) of the Bankruptcy Code allows recovery from (1) an initialtransferee, (2) an entity for whose bene�t the initial transfer wasmade, or (3) a subsequent transferee.180 The district court reiter-ated that, under the Eleventh Circuit's “control” test,181 the NewLenders, rather than the Transeastern Lenders, were the initialtransferees of the liens granted by the Conveying Subsidiaries,because they received the bene�t of those liens.182 Because theNew Lenders were the initial transferees, the Transeastern Lend-

transfer was the transfer of liens to the New Lenders rather than the transferof proceeds to the Transeastern Lenders. Id.

177Id. at 674.

178Id. at 670. The district court noted that it need not rule on this issue due

to its �nding that the Conveying Subsidiaries had received reasonably equiva-lent value for purposes of section 548(a)(1)(B) of the Bankruptcy Code. However,it reversed the bankruptcy court's ruling as clearly erroneous in order topreserve its result should the Eleventh Circuit sustain the bankruptcy court'srulings on reasonably equivalent value. Id. The Eleventh Circuit did so inTOUSA III. See In re TOUSA, Inc., 680 F.3d 1298, 56 Bankr. Ct. Dec. (CRR)135 (11th Cir. 2012).

179TOUSA II, 444 B.R. at 671. As further support, the district court quoted

several cases providing that the paradigm of an entity “for whose bene�t suchtransfer” is made is a guarantor of a debtor, and observed that the TranseasternLenders clearly did not �t this mold because they were not guarantors of thedebtor Conveying Subsidiaries. Id.

180Id.

181Id. at 672 (quoting In re Pony Exp. Delivery Services, Inc., 440 F.3d 1296,

1300, 46 Bankr. Ct. Dec. (CRR) 24, Bankr. L. Rep. (CCH) P 80465 (11th Cir.2006) (holding that an insurance broker who merely held a debtor's deposit tocover insurance premiums was not an initial transferee)). “[A] recipient of anavoidable transfer is an initial transferee only if they exercise legal control overthe assets received, such that they have the right to use the assets for their ownpurposes, and not if they merely served as a conduit for assets that were underthe actual control of the debtor-transferor or the real initial transferee.” 440F.3d at 1300.

182TOUSA II, 444 B.R. at 673.


1069

ers could only be, at most, subsequent transferees.183 However,the district court noted that since the liens remained with theNew Lenders and were never transferred to the TranseasternLenders, the Transeastern Lenders were not subsequent transfer-ees of the liens.184 The district court determined that for purposesof ordering recovery from the Transeastern Lenders, bankruptcycourt mistakenly concluded that the Transeastern Lenders wereboth initial transferees and entities for whose bene�t suchtransfers were made. This mistaken conclusion was based uponthe bankruptcy court's incorrect characterization of the series oftransactions that led to the payment of the New Loan proceeds tothe Transeastern Lenders as a “single integrated transaction,rather than a series of separate transactions.”185 As the districtcourt pointed out, not only was consolidating the transactionscontrary to the bankruptcy court's analysis of the various transac-tions under section 548 of the Bankruptcy Code—where the bank-ruptcy court did break down the transfers—but it was also un-supported by the documents underlying the transactions, whichmade clear that the various transactions made in connectionwith the New Loans were, in fact, separate.186

iii. The District Court Determined the TranseasternLenders Were Subsequent Transferees Who Could Not beLiable as Entities for Whose Bene�t the Transfer WasMade

The district court in TOUSA II also found that the bankruptcycourt further erred by relying on the “for whose bene�t” languagewithout considering whether the Transeastern Lenders weresubsequent transferees.187 The district court observed thatbecause “the structure of the statute separates the initialtransferees and bene�ciaries of initial transfers, on the one hand,from ‘immediate or mediate transferee[s]’ on the other,” section550(a) of the Bankruptcy Code links the initial transferee with

183Id. The district court explained that while the liability of “an initial

transferee[] or an entity for whose bene�t the initial transfer was made isabsolute . . . the liability of the subsequent transferee to the estate is not strictbut subject to the ‘good faith purchaser for value’ defense contained in § 550(b).”Id. at 671. The bankruptcy court did not �nd that the Transeastern Lenderswere either initial or subsequent transferees of the liens securing the NewLoans. Id. at 672.

184Id.

185Id.

186Id.

187Id. at 674.


1070

the entity for “whose bene�t” the initial transfer was made, suchthat “only a person (or entity) who receives a bene�t from theinitial transfer” can be an entity “for whose bene�t” the initialtransfer was made.188 Therefore, the Transeastern Lenders werenot entities “for whose bene�t” the transfer was made, because “asubsequent transferee cannot be the ‘entity for whose bene�t’ theinitial transfer was made.”189 The district court also clari�ed thatthe “for whose bene�t” language does not apply where the bene�tis not the immediate and necessary consequence of the initialtransfer, but instead is a result of the transfer's use by itsrecipient.190 Because the Transeastern Lenders were “subsequenttransferees” of the proceeds of the New Loan secured by the liens,the Transeastern Lenders did not qualify as “entities for whosebene�t” the transfers were made pursuant to section 550(a)(1) ofthe Bankruptcy Code. Thus, the district court found that theTranseastern Lenders were too far removed from the transfer ofliens by the Conveying Subsidiaries to be strictly liable as initialtransferees for a fraudulent transfer under section 550(a) of theBankruptcy Code.191

iv. As Subsequent Transferees the Transeastern LendersWere Protected Under Section 550(b) of the BankruptcyCode

The district court observed the bankruptcy court erroneouslyfound the Transeastern Lenders strictly liable without consider-

188Id. (emphasis supplied).

189Id. (citing In re Southeast Hotel Properties Ltd. Partnership, 99 F.3d 151,

155, 29 Bankr. Ct. Dec. (CRR) 1202, 36 Collier Bankr. Cas. 2d (MB) 1649,Bankr. L. Rep. (CCH) P 77158 (4th Cir. 1996); Bonded Financial Services, Inc.v. European American Bank, 838 F.2d 890, 897, 17 Bankr. Ct. Dec. (CRR) 299,18 Collier Bankr. Cas. 2d (MB) 155 (7th Cir. 1988) (an entity “for whose bene�t”a transfer was made cannot be a subsequent transferee); Lippi v. City Bank,955 F.2d 599, 611 (9th Cir. 1992) (same); In re Bullion Reserve of North America,922 F.2d 544, 548, 21 Bankr. Ct. Dec. (CRR) 326, 24 Collier Bankr. Cas. 2d(MB) 698, Bankr. L. Rep. (CCH) P 73771 (9th Cir. 1991) (noting that asubsequent transferee cannot be an entity for whose bene�t the initial transferwas made, even if the subsequent transferee actually receives a bene�t from theinitial transfer); In re Columbia Data Products, Inc., 892 F.2d 26, 28, 19 Bankr.Ct. Dec. (CRR) 1799, Bankr. L. Rep. (CCH) P 73106 (4th Cir. 1989) (same); In reUniversal Clearing House Co., 62 B.R. 118, 128 n.12 (D. Utah 1986) (“A readingof subsection (a)(1) in conjunction with the remainder of section 550 leads to theconclusion that the phrase ‘or the entity for whose bene�t such transfer wasmade’ refers to those who receive a bene�t as a result of the initial transferfrom the debtor—not as the result of a subsequent transfer”)).

190TOUSA II, 444 B.R. at 674.

191Id.


1071

ing the possibility that the transfers of the proceeds of the NewLoan to the Transeastern Lenders were not recoverable undersection 550(a)(2) by virtue of the defense to liability provided insection 550(b) of the Bankruptcy Code,192 which “precludesrecovery from a subsequent transferee that takes for value,including satisfaction . . . of a[n] . . . antecedent debt in goodfaith” and without knowledge of the voidability of the transfer,193

as the Transeastern Lenders took the New Loan proceeds forvalue, in satisfaction of a valid antecedent debt.194 Refusing toremand on this issue, the district court noted that section 550(b)does not require that value supplied by the subsequent transfereebe provided to the debtor and found that the satisfaction ofTOUSA's valid antecedent debt satis�ed the value prong of sec-tion 550(b).195 The district court also found that the Committeehad o�ered no evidence establishing (a) that the TranseasternLenders acted in bad faith in entering into the Settlement, or (b)accepted repayment on their valid antecedent debt with knowl-edge of the voidability of the transfer to the New Lenders,notwithstanding the bankruptcy court's �nding that the Tran-seastern Lenders acted in bad faith because they knew or shouldhave known on the basis of publically available information thatTOUSA and the Conveying Subsidiaries were insolvent or closeto being insolvent at the time of the Settlement.196

In reversing the bankruptcy court on this particular holding,the district court found that such a ruling “impose[d] extraordi-nary duties of due diligence on the part of creditors acceptingrepayment duties that equal or exceed those imposed on lendersextending credit in the �rst place. To the contrary, the districtcourt found that the Transeastern Lenders, as recipients of adebt payment, had no reason or legal duty to conduct suchextraordinary due diligence with respect to the provenance of thefunds with which they were being repaid.”197

In concluding, the district court chastised the bankruptcy court

19211 U.S.C. § 550(b). See section II.B. of this article for the language of and

background on section 550(b).193

TOUSA II, 444 B.R. at 674. There was no question that the payment ofthe undisputed antecedent debt owed to the Transeastern Lenders satis�ed thevalue requirement of § 550(b) as such value need not be to the debtor. Id. at674–75.

194Id.

195Id. at 675.

196Id. at 675.

197Id. at 675–76.


1072

for �nding, without pointing to any evidentiary support, that theTranseastern Lenders acted in bad faith and were grosslynegligent because they (a) knew or should have known thatTOUSA and its subsidiaries were insolvent when they enteredinto the New Loan transactions, and (b) should have examinedthe debtors' �nancial structure to ascertain that the ConveyingSubsidiaries were to receive reasonably equivalent value as aresult of the transactions.198 The district court distilled the bank-ruptcy court's ruling in regard to the Transeastern Lenders as “itis ‘bad faith’ for a creditor of someone other than the debtor to ac-cept payment of a valid, tendered debt repayment outside of anypreference period, through settlement or otherwise, if the credi-tor does not �rst investigate the debtor's internal re-�nancingstructure and ensure that the debtor's subsidiaries had receivedfair value as part of the repayment, or that the debtor and itssubsidiaries, in an enterprise, were not insolvent or precariouslyclose to being insolvent.”199 The district court criticized theexhaustive duties such an expansion of the requirements of sec-tion 550 of the Bankruptcy Code would impose on banks andother creditors, stating that such a �nding is “patently unreason-able and unworkable,” would vastly expand the duties ofsubsequent transferees, and is not supported by applicable bank-ruptcy and non-bankruptcy law.200

4. TOUSA III—A Return to Liability for TranseasternLendersThe Committee appealed the TOUSA II decision to the

Eleventh Circuit Court of Appeals, and the New Lenders' relatedappeals of the bankruptcy court's ruling to the district court thatwere pending at the time of the TOUSA II decision were stayedpending the determination by the Eleventh Circuit.201 On appeal,the Committee sought reversal of TOUSA II and a�rmance ofthe bankruptcy court's determinations that (a) the ConveyingSubsidiaries did not receive reasonably equivalent value inexchange for the transfers to the New Lenders, and (b) theTranseastern Lenders are entities for whose bene�t the transferswere made. The Committee further argued that the case shouldbe remanded to the district court, and consolidated with the ap-

198Id. at 675.

199Id.

200Id.

201See Order Staying and Administratively Closing Case, Wells Fargo Bank,

NA v. O�cial Committee of Unsecured Creditors, No. 10-cv-60018 (S.D. Fla.March 28, 2011).


1073

peals of the New Lenders that are pending before JudgeAldaberto Jordan, while the Transeastern Lenders argued on ap-peal that the remedies ordered by the bankruptcy court should bevacated.202

Reviewing �ndings of fact for clear error, the determinations oflaw de novo and equitable determinations for abuse of discretion,the Eleventh Circuit agreed with the Committee that the Convey-ing Subsidiaries did not receive reasonably equivalent value inexchange for their liens, held that the Transeastern Lenderswere entities for whose bene�t the liens were transferred, andremanded to the district court the issues of judicial assignmentand consolidation raised by the parties.203 In addition, theEleventh Circuit refused to address the arguments raised by theTranseastern Lenders regarding the remedies ordered by thebankruptcy court, because such issues had not been consideredby the district court.204 These issues were also remanded to thedistrict court.

Regarding the question of whether the Conveying Subsidiarieshad received reasonably equivalent value, the Eleventh Circuitfound that the bankruptcy court did not clearly err when it foundthat the Conveying Subsidiaries did not receive reasonably equiv-alent value when they conveyed the liens to the New Lenders.205

In so �nding, the Eleventh Circuit stated that it need not addressthe question of whether the bankruptcy court erred when itadapted a narrow de�nition of “value,” because the record sup-ports the bankruptcy court's conclusion that, whether or not theavoidance of bankruptcy constituted value to the Conveying Sub-sidiaries, any value provided to the Conveying Subsidiaries wasfar outweighed by the costs of the transactions at issue.206 In sup-port of this holding, the Eleventh Circuit pointed to the bank-ruptcy court's conclusion that, even if all of the TOUSA entitieswould have immediately collapsed into bankruptcy but for the

202See Committee Brief and Committee Reply Brief, Senior Transeastern

Lenders v. O�cial Comm. of Unsecured Creditors, No. 11-11071 (11th Cir., May6, 2011 and June 18, 2011). As noted supra at note 103, certain of the partiesentered into a partial settlement that resolves some economic issues butprovided for the completion of the appeal to the Eleventh Circuit.

203In re TOUSA, Inc., 680 F.3d 1298, 56 Bankr. Ct. Dec. (CRR) 135 (11th

Cir. 2012).204

TOUSA, 680 F.3d 1298 (citing In re Prudential of Florida Leasing, Inc.,478 F.3d 1291, 1303, 47 Bankr. Ct. Dec. (CRR) 212, 57 Collier Bankr. Cas. 2d(MB) 684, Bankr. L. Rep. (CCH) P 80852 (11th Cir. 2007)).

205Id. at *12–14.

206Id. at *12.


1074

Settlement, the Settlement and related transactions were “stillthe more harmful option.”207 The Eleventh Circuit dismissed theTranseastern Lenders and New Lenders' arguments that such aconclusion was unsupportable, stating that the weight of the evi-dence available at the time of the Settlement demonstrated that,due to the economic climate in the homebuilding industry, aswell as TOUSA's internal �nancial weaknesses, the bankruptciesof the TOUSA entities were inevitable.208

In addressing the issue of whether the Transeastern Lenderswere entities from whom recovery could be ordered under section550(a)(1) of the Bankruptcy Code, the Eleventh Circuit foundthat the plain language of the statute, combined with thelanguage of the documents governing the New Loan, supportedthe conclusion that the Transeastern Lenders were entities “forwhose bene�t” the Conveying Subsidiaries transferred the liens.209

In so holding, the Eleventh Circuit relied on its decision in In reAir Conditioning,210 where the circuit found that a trustee couldrecover from the creditor of a company the value of the securityposted to secure a letter of credit issued to the creditor on behalfof the debtor.211 The reasoning behind Air Conditioning was thatthe transfer of the collateral to the bank that issued the letter ofcredit was a voidable preference because it enabled the creditorto receive more value than it would have in liquidation, and thatthe creditor was the entity for whose bene�t the transfer wasmade because the creditor, rather than the issuer, received thebene�t of the transfer in the form of the letter of credit.212 TheEleventh Circuit reasoned in TOUSA III that the Conveying Sub-sidiaries were in a position analogous to that of the creditor inAir Conditioning, and rejected the Transeastern Lenders' argu-ments that Air Conditioning was distinguishable because theTOUSA case did not involve an avoidable preference or a letter ofcredit.213

The Eleventh Circuit also rejected the Transeastern Lenders'

207Id. at *13 (citing TOUSA I, 422 B.R. at 847 (emphasis supplied)).

208Id. at *13–14.

209Id. at *14.

210In re Air Conditioning, Inc. of Stuart, 845 F.2d 293, 17 Bankr. Ct. Dec.

(CRR) 1385, 18 Collier Bankr. Cas. 2d (MB) 973, Bankr. L. Rep. (CCH) P 72302(11th Cir. 1988).

211Id. at 299.

212Id.

213In re TOUSA, Inc., 680 F.3d 1298, 56 Bankr. Ct. Dec. (CRR) 135 (11th

Cir. 2012).


1075

argument that they could not be liable under section 550(a)(1)because they were not the initial transferees of the ConveyingSubsidiaries' liens, but rather only bene�tted from the subsequenttransfer of funds from TOUSA.214 The circuit emphasized thatbecause the documents governing the New Loan required thatthe proceeds be used to pay the Settlement, it did not matter thatthe funds passed through a TOUSA subsidiary before they werewired to the Transeastern Lenders. Under the terms of the NewLoan documents, the subsidiary never had control over thefunds.215 In response to the Transeastern Lenders' argument thatsuch a ruling would impose “extraordinary” duties on creditorsaccepting repayment, the circuit court noted that “[i]t is far froma drastic obligation to expect some diligence from a creditor whenit is being repaid hundreds of millions of dollars by someoneother than its debtor.”216

While TOUSA II provided a brief breathing spell for lenders,TOUSA III's a�rmance of the bankruptcy court's opinionreinstates, at least in the Eleventh Circuit, duties on lenders toinvestigate a borrower's �nancial condition during repaymentperhaps more stringently than they would when underwriting anew loan.

B. Reasonably Equivalent Value and Good Faith inPonzi Schemes

Some of the most interesting decisions related to fraudulenttransfer law in 2011 were borne out of the fertile ground of Ponzischemes.217 The multibillion-dollar Ponzi scheme orchestrated byBernard L. Mado� (“Mado�”) as well as other recent Ponzi

214TOUSA, 680 F.3d 1298.

215Id. (citing In re Chase & Sanborn Corp., 848 F.2d 1196, 1199, Bankr. L.

Rep. (CCH) P 72363 (11th Cir. 1988) (stating that courts must apply a “very�exible, pragmatic” test that “look[s] beyond the particular transfers in questionto the entire circumstance of the transactions” when deciding whether debtorshad controlled property later sought by their trustees); Bonded FinancialServices, Inc. v. European American Bank, 838 F.2d 890, 893, 17 Bankr. Ct.Dec. (CRR) 299, 18 Collier Bankr. Cas. 2d (MB) 155 (7th Cir. 1988) (holdingthat a bank was not an initial transferee because it held funds “only for thepurpose of ful�lling an instruction to make the funds available to someoneelse”)).

216Id.

217A Ponzi scheme is an investment scheme that is not supported by a legit-

imate underlying business venture. Early investors are paid pro�ts from themonies provided by new investors. Usually investors in the scheme are promisedlarge returns on their principal investments. Initial investors are often paid siz-able promised returns. This attracts additional investors. More and more inves-


1076

schemes218 have resulted in a plethora of avoidance actions andnumerous remarkable decisions.

Ponzi scheme cases are typically about unraveling the schemeand recovering assets for redistribution to investors and creditors.Recent litigation reveals the tension between prosecutors, trust-ees, creditors, innocent investors and investors who arguablyknew or should have known of the scheme, and some of theinconsistencies in securities laws and bankruptcy laws. Courtsgrapple with issues of “�ctitious” pro�ts, and clashes between“net winners” and “net losers” of schemes, i.e., those parties whoreceived Ponzi scheme payments exceeding their principal invest-ment versus those parties who either never redeemed or werepaid less than the amounts they invested. Thus, courts have beenrequired to examine the unique issues surrounding avoidanceand recovery of fraudulent transfers in the Ponzi scheme context.Among the developments of 2011 in this area of law219 are deci-sions recently issued by the Eleventh Circuit Court of Appeals in

tors need to be attracted into the scheme so that the growing number of inves-tors on top can get paid. The Ponzi scheme acquired its name from Charles K.Ponzi (1882–1949) who during an eight-month period in 1920 swindled Ameri-can investors for an amount in excess of $15 million. See Balaber-Strauss v.Lawrence, 264 B.R. 303, 305–06, 46 Collier Bankr. Cas. 2d (MB) 851 (S.D. N.Y.2001).

218Other recently exposed Ponzi schemes include those perpetrated by:

George Lindell (see Harry Eager, Mortgage Store Owners Agree to Pay $6 mil-lion, The Maui News (January 20, 2012)); David Nilsen (see Larry Parsons,Cedar Funding Owner David Nilsen Pleads Guilty to Fraud, Monterey Herald,October 25, 2011, http://www.montereyherald.com/ci�19187759?source=most�viewed (last visited April 24, 2012)); Lloyd Kimura (see Harry Eagar, JudgeImposes 20 years in Kimura Ponzi Scheme, The Maui News (August 5, 2011));Scott Rothstein (see Ashby Jones, Rothstein Draws 50-Year Sentence: FormerFlorida Lawyer Was Convicted of Running a $1.2 Billion Ponzi Scheme, TheWall Street Journal, June 10, 2010, http://online.wsj.com/article/SB10001424052748704575304575296662423872880.html?dbk (last visited April24, 2012)); Marc Drier (see Benjamin Weiser, Lawyer Pleads Guilty in $400Million Fraud, N.Y. Times, May 11, 2009, http://www.nytimes.com/2009/05/12/nyregion/12dreier.html (last visited April 24, 2012)); Tom Petters (see 50-YearTerm for Minnesota Man in $3.7 Billion Ponzi Fraud, N.Y. Times, April 8, 2009,http://www.nytimes.com/2010/04/09/business/09ponzi.html (last visited April 24,2012)); and Allen Stanford (see Press Release: SEC Charges R. Allen Stanford,Stanford International Bank for Multi-Billion Dollar Investment Scheme, Feb.17, 2009, http://www.sec.gov/news/press/2009/2009-26.htm (last visited April 24,2012)).

219Several signi�cant decisions issued this year in the Ponzi scheme area

touched on several topics related to sections 548 and 550 of the BankruptcyCode that are not discussed at length in this article, such as the safe harborprovided under section 546(e) of the Bankruptcy Code, withdrawal of the refer-ence from the bankruptcy court to the district court, satisfaction of pleading


1077

Perkins v. Haines,220 and by the District Court for the SouthernDistrict of New York in the liquidation proceedings of Bernard L.Mado� Investment Securities LLC (“BLMIS”) in the adversarycases of Picard v. Katz221 and Picard v. Merkin.222

The Eleventh Circuit, in Haines,223 held that investors in aPonzi scheme are entitled to rely upon the a�rmative defenseprovided in section 548(c) of the Bankruptcy Code for paymentsmade in redemption of their principal, �nding that that the inves-tors took “for value and in good faith” when they received pay-ments in redemption of the principal amount of their equity

standards for purposes of motions to dismiss, and the standing of SIPA trusteesto assert creditors' causes of action pursuant to § 544 of the Bankruptcy Codeand common law causes of action. See, e.g., Picard v. Katz, 462 B.R. 447, 55Bankr. Ct. Dec. (CRR) 133, Bankr. L. Rep. (CCH) P 82077 (S.D. N.Y. 2011),motion to certify appeal denied, 466 B.R. 208, 55 Bankr. Ct. Dec. (CRR) 266(S.D. N.Y. 2012) (§ 546(e) safe harbor); Picard v. Flinn Investments, LLC, 463B.R. 280 (S.D. N.Y. 2011) (withdrawal of reference); Picard v. JPMorgan Chase& Co., 460 B.R. 84, 55 Bankr. Ct. Dec. (CRR) 201, 66 Collier Bankr. Cas. 2d(MB) 1208 (S.D. N.Y. 2011) (SIPA trustee standing to bring actions on behalf ofcustomers against Mado�'s banks for aiding and abetting fraud and breach of �-duciary duty); Picard v. HSBC Bank PLC, 454 B.R. 25, 55 Bankr. Ct. Dec.(CRR) 58 (S.D. N.Y. 2011), opinion amended, 2011 WL 3477177 (S.D. N.Y.2011) (SIPA trustee's standing to assert common law claims on behalf of custom-ers of defunct brokerage �rm against third parties); Picard v. HSBC Bank PLC,450 B.R. 406, Fed. Sec. L. Rep. (CCH) P 96302 (S.D. N.Y. 2011) (withdrawal ofreference); Securities Investor Protection Corp. v. Bernard L. Mado� Inv. Securi-ties LLC, 454 B.R. 307 (S.D. N.Y. 2011) (withdrawal of reference); In re Fair�eldSentry Ltd. Litigation, 458 B.R. 665 (S.D. N.Y. 2011) (bankruptcy court jurisdic-tion in Chapter 15 case); Picard v. Katz, 2011 WL 7267859 (S.D. N.Y. 2011)(withdrawal of reference); In re Bernard L. Mado� Inv. Securities LLC, 458 B.R.87, 55 Bankr. Ct. Dec. (CRR) 139 (Bankr. S.D. N.Y. 2011), leave to appealdenied, 464 B.R. 578 (S.D. N.Y. 2011) (pleading standards for, among otherthings, avoidance claims).

220Perkins v. Haines, 661 F.3d 623, 55 Bankr. Ct. Dec. (CRR) 166, Bankr. L.

Rep. (CCH) P 82094 (11th Cir. 2011) (“Haines”).221

Picard v. Katz, 462 B.R. 447, 55 Bankr. Ct. Dec. (CRR) 133, Bankr. L.Rep. (CCH) P 82077 (S.D. N.Y. 2011), motion to certify appeal denied, 466 B.R.208, 55 Bankr. Ct. Dec. (CRR) 266 (S.D. N.Y. 2012).

222In re Bernard L. Mado� Inv. Securities LLC;, 2011 WL 3897970 (S.D.

N.Y. 2011) (“Merkin II”) (denying defendants leave to appeal the bankruptcycourt's decision in In re Bernard L. Mado� Inv. Securities, LLC, 440 B.R. 243,53 Bankr. Ct. Dec. (CRR) 268, 64 Collier Bankr. Cas. 2d (MB) 957 (Bankr. S.D.N.Y. 2010), leave to appeal denied, 2011 WL 3897970 (S.D. N.Y. 2011)). A deci-sion from the liquidation of Dreier LLP is also signi�cant, but not fully ad-dressed in this article. See In re Dreier LLP, 452 B.R. 391 (Bankr. S.D. N.Y.2011).

223Perkins v. Haines, 661 F.3d 623, 55 Bankr. Ct. Dec. (CRR) 166, Bankr. L.

Rep. (CCH) P 82094 (11th Cir. 2011).


1078

interests in the debtor through which the scheme operated.224 Thestandard applicable to the “good faith” defense of section 548(c)for recipients of transfers from Ponzi schemes continues to be anarea of substantial controversy.225 In 2011, that standard was ad-dressed by two di�erent district court judges in avoidance actionspending in the liquidation proceedings of BLMIS226 in Merkin II227

224Id. Proposed legislation, which appears to have stalled at the House

Committee on Financial Services, could potentially limit the power of court-appointed trustees marshalling assets of bankrupt brokerages, to beginclawback suits against those defendants that are “net winners.” EquitableTreatment of Investors Act, H.R. 6531, 111th Cong., 2d Sess (2010). H.R. 6531would amend SIPA to require that trustees determine claims of loss accordingto �nal account statements, except where the claimant knew that the failedbroker-dealer was involved in fraud. This proposed change would update thecurrent law, which does not specify the formula for calculating the amount of aclaim.

225This issue was the focus of the Bayou IV and Merkin I decisions. See Gal-

lagher, supra note 24, at section III.A. for a discussion of the cases of In reBayou Group, LLC, 439 B.R. 284 (S.D. N.Y. 2010) (reversing a bankruptcy courtruling lowering the level of knowledge required to bar Ponzi scheme investorsfrom relying on the “good faith” defense by holding that investors who receivedredemption payments are denied the defense if they were aware of “some in�r-mity” in the Ponzi scheme entity (i.e. a subjective test); the district court heldthat the applicable standard was whether the red �ags raised would have put a“reasonable hedge fund investor” on inquiry notice of the company's fraudulentscheme (i.e. an objective test)) and Merkin I (holding, inter alia, that a determi-nation on the “good faith” defense in Ponzi scheme was premature when rulingon motion to dismiss that defendants might not be entitled to assert restitutionclaims as “reasonably equivalent value,” and that it was premature to rule ondefendant's defense that transfers were sheltered by safe harbor of section546(e), but indicating safe harbor might not apply where no securities transferstook place). Following a trial in the Bayou case, the district court ruled, pursu-ant to a jury verdict, that the defendants had failed to prove, by a preponder-ance of the evidence, that they were not aware of information that would haveput a “reasonable hedge fund investor” on inquiry notice of the funds' fraudu-lent purpose or that the defendants performed a diligent investigation (or,alternatively, that such diligent investigation would not have turned up evi-dence of the fraud), perhaps rendering illusory the objective standard of BayouIV. See Memorandum Opinion and Order, In re Bayou Grp., LLC, No. 09-cv-02340 (S.D.N.Y. Feb. 6, 2012). On February 6, 2012, the district court deniedthe defendants' motion for judgment as a matter of law seeking reversal of thejury's verdict. Id.

226The liquidation proceedings of BLMIS are pending in In re Bernard L.

Mado� Inv. Sec. LLC, Bankr. S.D.N.Y. No. 08-01789 (BRL). BLMIS is being liq-uidated pursuant to the Securities Investor Protection Act (“SIPA”), 14 U.S.C.§§ 78aaa et seq. Congress enacted SIPA in 1970 for the primary purpose ofprotecting customers from losses caused by the insolvency or �nancial instabil-ity of broker-dealers. See In re Bernard L. Mado� Inv. Securities LLC, 424 B.R.122, 132, 52 Bankr. Ct. Dec. (CRR) 236, Bankr. L. Rep. (CCH) P 81726 (Bankr.


1079

and Picard v. Katz,228 respectively—and it appears that there is ashift away from the objective standard for analyzing the goodfaith a�rmative defense in Ponzi scheme cases.229 Of particularsigni�cance, the district court in Picard v. Katz in granting inpart the defendants' motion to dismiss230 held that the safe harborof section 546(e) sheltered constructively fraudulent transfersmade to investors in the BLMIS Ponzi scheme and that pay-ments made in redemption of investors' principal are recoverableas fraudulent transfers only if received in bad faith, a decisionthat neither the bankruptcy court nor the district court was will-ing to make in Merkin I and Merkin II.231

1. Perkins v. Haines—“Good Faith” Shelters PrincipalInvestmentThe Court of Appeals for the Eleventh Circuit in Haines

recently held, in a case of �rst impression in the circuit, thatequity investors in a Ponzi scheme are entitled to invoke the af-�rmative defense of taking in “good faith” and “for value” includedin section 548(c) of the Bankruptcy Code.232 In Haines, the plan

S.D. N.Y. 2010) (citing Securities and Exchange Commission v. S. J. Salmon &Co., Inc., 375 F. Supp. 867, 871, Fed. Sec. L. Rep. (CCH) P 94582 (S.D. N.Y.1974)). SIPA establishes procedures for liquidating failed broker dealers andprovides customers of broker dealers with special protections. Id. at 132–33. ASIPA liquidation is essentially a bankruptcy liquidation tailored to achieveSIPA's objectives. Id. at 133 (citing 15 U.S.C. § 78�f(b)).

227In re Bernard L. Mado� Inv. Securities LLC;, 2011 WL 3897970 (S.D.

N.Y. 2011).228

Picard v. Katz, 462 B.R. 447, 55 Bankr. Ct. Dec. (CRR) 133, Bankr. L.Rep. (CCH) P 82077 (S.D. N.Y. 2011), motion to certify appeal denied, 466 B.R.208, 55 Bankr. Ct. Dec. (CRR) 266 (S.D. N.Y. 2012).

229The standard for analyzing the good faith defense set forth in section

548(c) of the Bankruptcy Code was also analyzed at length by the bankruptcycourt in the Ponzi scheme bankruptcy case of Dreier LLP. See In re Dreier LLP,452 B.R. 391 (Bankr. S.D. N.Y. 2011).

230Picard v. Katz, 462 B.R. at 453.

231See In re Bernard L. Mado� Inv. Securities LLC;, 2011 WL 3897970, *11

(S.D. N.Y. 2011).232

Perkins v. Haines, 661 F.3d 623, 55 Bankr. Ct. Dec. (CRR) 166, Bankr. L.Rep. (CCH) P 82094 (11th Cir. 2011) (a�rming bankruptcy court's denial of theplan trustee's motion for summary judgment). Haines did not address the stan-dard for analyzing “good faith” for purposes of section 548(c). It appears thatthe plan trustee brought only claims alleging actually fraudulent transfer and,thus, the safe harbor provided by section 546(e) was not implicated in Haines.See supra section II.A. note 38 of this article for the language of section 548(c)of the Bankruptcy Code.


1080

trustee233 for debtors that had been utilized as instruments of aPonzi scheme commenced several actions seeking to avoiddistributions made to the debtors' equity holders as actual fraud-ulent transfers under section section 548(a)(1)(A) of the Bank-ruptcy Code.234 The debtors were formed and purported to beoperated as hedge funds and the defendants were equity inves-tors in the funds pursuant to agreements with the debtors. Dur-ing the course of the Ponzi scheme, each of the defendantsreceived transfers that represented returns of principal and/or“pro�ts” on those equity investments.235

Consistent with precedent from several other jurisdictions, theEleventh Circuit observed that transfers made in furtherance ofa Ponzi scheme are presumed to have been made with the intentto defraud for purposes of Bankruptcy Code sections 544 and 548,due to the fraudulent nature of the scheme itself (the “PonziScheme Presumption”).236 However, the Eleventh Circuit notedthat a good faith a�rmative defense under section 548(c) mayshelter those transfers to the extent that value was provided tothe debtor.237 The Eleventh Circuit observed that, under prece-dent from other jurisdictions,238 defrauded investors were foundto have provided value for purposes of section 548(c) to the extentof their principal investment, but such �ndings did not extend topayments of amounts exceeding the principal amount of theirinvestments.239 The rationale for this rule is that defrauded inves-tors are deemed to hold fraud claims against the debtor for the

233The plan trustee in Haines was appointed pursuant to the debtors' plan

of liquidation. Haines, 661 F.3d at 625.234

The debtors in Haines were International Management Associates, LLCand several related entities. They were formed by Kirk Wright, who purportedlymanaged and operated them as hedge funds. Id. at 626.

235Id.

236Id. (citing In re AFI Holding, Inc., 525 F.3d 700, 704, 49 Bankr. Ct. Dec.

(CRR) 243, Bankr. L. Rep. (CCH) P 81218 (9th Cir. 2008); Conroy v. Shott, 363F.2d 90, 92, 9 Ohio Misc. 117, 37 Ohio Op. 2d 328, 38 Ohio Op. 2d 157 (6th Cir.1966); In re World Vision Entertainment, Inc., 275 B.R. 641, 656 (Bankr. M.D.Fla. 2002)). A more complete description of the Ponzi Scheme Presumption canbe found in note 264 of this article.

237Haines, 661 F.3d at 626.

238Id. at 627 (citing Donell v. Kowell, 533 F.3d 762, 770 (9th Cir. 2008);

Scholes v. Lehmann, 56 F.3d 750, 757–58 (7th Cir. 1995); Eby v. Ashley, 1 F.2d971 (C.C.A. 4th Cir. 1924)).

239Id. (citing In re Hedged-Investments Associates, Inc., 84 F.3d 1286, 1290,

35 Collier Bankr. Cas. 2d (MB) 1424 (10th Cir. 1996)).


1081

principal amount of their investment.240 Therefore, when theprincipal investment amount is returned to the investor, value isprovided to the debtor through satisfaction of a valid antecedentdebt, i.e. the investor's fraud claim.241 However, as the EleventhCircuit recognized, the cases so holding were not directly ap-posite because they did not speci�cally address the unique situa-tion of investors who are equity holders of the instruments ofPonzi schemes.242

The trustee in Haines argued that the transfers to the inves-tors could not have been made for value because they were notmade to extinguish any type of claim or debt against the debtor,relying on a line of cases holding that transfers to redeem equityinvestments in insolvent entities, including, in some instances,transfers made without actual or constructive fraud, do not con-stitute transfers for value.243 The Eleventh Circuit distinguishedthose decisions on the basis that they were not decided in thecontext of a Ponzi scheme and involved only claims of construc-tive fraud, not actual fraud, as is typically the case in a Ponzischeme. Unlike the situation present in Haines, the cases reliedupon by the trustee involved circumstances in which the debtorsattempted to pay o� their shareholders at the expense of credi-tors, but not where the investors were fraudulently induced toinvest in the scheme.244

In concluding that the applicability of the section 548(c) goodfaith defense is not dependent upon the type of investments madein a Ponzi scheme context, the Eleventh Circuit explained thatcourts have not distinguished between equity investments anddebt-based investments when evaluating fraudulent transferclaims in Ponzi scheme bankruptcies245 and relied upon the Ninth

240Id. (citing In re M & L Business Mach. Co., Inc., 84 F.3d 1330, 1340–42,

29 Bankr. Ct. Dec. (CRR) 188, 36 Collier Bankr. Cas. 2d (MB) 996 (10th Cir.1996); In re United Energy Corp., 944 F.2d 589, 596, 22 Bankr. Ct. Dec. (CRR)143, 25 Collier Bankr. Cas. 2d (MB) 740, Bankr. L. Rep. (CCH) P 74294 (9thCir. 1991)).

241Id.

242Id.

243Id.

244Id. at 628.

245Id. Interestingly, the Eleventh Circuit did not address any of the recent

precedent emanating from the Bayou or Mado� lines of cases.


1082

Circuit's 2008 decision in In re AFI Holding, Inc.246 The investorsin AFI Holding purchased equity interests in the debtor, andreceived transfers during the operation of the scheme which werecomprised both of purported returns on those equity investmentsand pro�ts.247 The trustee in AFI Holding sought to avoid thosetransfers, and the bankruptcy court authorized avoidance, �nd-ing that the transfers were not given “for value.”248 The districtcourt reversed, holding that the transfers were made in satisfac-tion of the defrauded investors' restitution claims against thedebtor.249 The Ninth Circuit Court of Appeals a�rmed, holdingthat the investors “were defrauded into their limited partnershiprole by the operator of the Ponzi scheme.”250 Therefore, the NinthCircuit determined that the investors held restitution claims inthe amounts of their investments and that the transfers at issuesatis�ed such claims.251 Similarly, in Haines, the Eleventh Circuitupheld the bankruptcy court's denial of the trustee's motion forsummary judgment, thus validating the investors' ability to as-sert the a�rmative defense that the payments to them werereceived in good faith and for value up to the amount of eachinvestor's principal investment.252

246See id. at 628 (citing In re AFI Holding, Inc., 525 F.3d 700, 708, 49 Bankr.

Ct. Dec. (CRR) 243, Bankr. L. Rep. (CCH) P 81218 (9th Cir. 2008)).247

In re AFI Holding, 525 F.3d at 702.248

See id. at 704.249

Id.250

Id. at 708.251

Id.252

Haines, 661 F.3d at 629. Without mentioning Haines, the United StatesBankruptcy Court for the Southern District of Florida recently examinedwhether to suspend the continued prosecution of a trustee's avoidance actionsagainst a Ponzi scheme's “net losers” in the Chapter 11 case of In re RothsteinRosenfeldt Adler P.A. See 464 B.R. 465 (Bankr. S.D. Fla. 2012). RothsteinRosenfeldt Adler P.A. was a law �rm through which Scott Rothstein operated aPonzi scheme centered around the sale of interests in �ctitious structuredlawsuit settlements. After the scheme collapsed and the �rm �led for bank-ruptcy protection, the trustee commenced avoidance actions against variousparties, including “net winners” (those who collected more than they invested)and “net losers” (those who did not recover their principal investment). Certainof the investors moved to abate avoidance actions against certain net losers,purportedly so that the trustee could focus his attention and the estate's re-sources on litigation targets the movants deemed most culpable. The courtdenied the motion, citing a lack of detail about the proposed abatement's lengthand clear criteria for identifying and classifying net losers versus net winners.Signi�cantly, the court observed that the motion was predicated on the assump-tion that the net losers had acted in good faith, an issue on which the defendants


1083

2. Merkin II—Leave To Appeal DeniedLast year's edition of this article featured the bankruptcy

court's decision in Picard v. Merkin253 denying the defendants'(the “Merkin Defendants”)254 motions to dismiss the SIPAtrustee's complaint seeking to avoid and recover allegedly fraud-ulent payments made to the Merkin Defendants in connectionwith their investments in BLMIS.255 Merkin I held (a) that it waspremature at the pleading stage to address the a�rmative defen-ses provided by sections 548(c) and 546(e) of the BankruptcyCode and (b) that the determination of whether the defendants'restitution claims provided reasonably equivalent value to defeatthe trustee's claims alleging constructive fraud was inappropriatefor a motion to dismiss, particularly where the trustee hadadequately alleged that the defendants knew of Mado�'s fraudand might not be entitled to the equitable claim of restitution.256

Merkin II is the district court's consideration of a motion forleave to appeal the Merkin I decision.

In Merkin II, Judge Kimba Wood of the United States DistrictCourt for the Southern District of New York denied in its en-tirety the motion of the receiver for two of the Merkin Defendants,Ariel Fund Ltd. and Gabriel Capital L.P. (the “Funds”), seekingleave to appeal the bankruptcy court's denial of the motion todismiss. In so doing, Judge Wood (a) ruled that the defendantsfailed to satisfy the standards for granting leave to appeal setforth in 28 U.S.C. § 1292(b) because there were no substantial

plainly had the burden of proof under section 548(c) of the Bankruptcy Code.Absent factual discovery, the court found it was impossible to tell whether netlosers were any less culpable than net winners. The court pointed out, sincemany avoidance action defendants in non-Ponzi scheme cases are owed morethan they recovered from transfers that are the subject of avoidance actions, al-lowing the abatement of actions against self-proclaimed net losers in a Ponzischeme could e�ectively elevate net losers above other types of defendants, suchas trade creditors. Id. at 470.

253In re Bernard L. Mado� Inv. Securities, LLC, 440 B.R. 243, 53 Bankr. Ct.

Dec. (CRR) 268, 64 Collier Bankr. Cas. 2d (MB) 957 (Bankr. S.D. N.Y. 2010),leave to appeal denied, 2011 WL 3897970 (S.D. N.Y. 2011).

254The Merkin Defendants were funds that were managed by J. Ezra Merkin

(“Merkin”) and direct and indirect investors BLMIS, the vehicle through whichMado� orchestrated a massive Ponzi scheme. Merkin was the sole generalpartner of Gabriel Capital; he was also the sole shareholder and sole director ofGabriel Capital Corporation, which in turn was the investment advisor to ArielFund Ltd. In re Bernard L. Mado� Inv. Securities LLC, 2011 WL 3897970, *1(S.D. N.Y. 2011).

255Gallagher, supra note 24 at Section III.A.2.

256See Merkin I, 440 B.R. at 273.


1084

grounds for disputing the correctness of the bankruptcy court'sdecision in Merkin I and (b) held that an immediate review of thebankruptcy court's non-�nal order with respect to that decisionwas not required.257

With respect to the adequacy of the pleadings, the district court�rst observed that the bankruptcy court's decision denying theMerkin Defendants' motion to dismiss held that the SIPA trusteehad su�ciently pleaded his federal and state law claims seekingavoidance and recovery of actual fraudulent transfers. In thatregard, the bankruptcy court also held that the Merkin Defen-dants were not entitled to dismissal of claims asserting actualfraudulent transfer claims on the basis of the “good faith” a�r-mative defense provided in section 548(c) of the BankruptcyCode.258 Second, the bankruptcy court held that the SIPA trusteehad su�ciently pleaded his federal and state law claims seekingavoidance of allegedly constructively fraudulent transfers and, inthis regard, the Merkin Defendants were not entitled to dismissalof Bankruptcy Code-based constructive fraud claims pursuant tothe safe harbor a�rmative defense applicable to certain “settle-ment payments” contained in section 546(e) of the BankruptcyCode.259

The district court reviewed in detail the issues raised by theFunds260 and, in each instance, determined that the Funds werenot entitled to an immediate appeal, as no substantial grounds

257In re Bernard L. Mado� Inv. Securities LLC, 2011 WL 3897970, *1 (S.D.

N.Y. 2011). Section 1292(b) of title 28 of the United States Code provides that adistrict judge may allow for an appeal of a civil order that is otherwise not ap-pealable if the judge is “of the opinion that such order involves a controllingquestion of law as to which there is substantial ground for di�erence of opinionand that an immediate appeal from the order may materially advance theultimate termination of the litigation.” 28 U.S.C. § 1292(b). The district courtnoted that, in addition to the three factors required by the statute, the movantmust establish that ‘‘ ‘exceptional circumstances . . . [exist that] . . . overcomethe general aversion to piecemeal litigation’ and justify departing from the basicpolicy of postponing appellate review until after entry of a �nal judgment.” In reBernard L. Mado� Inv. Securities LLC, 2011 WL 3897970, *3 (S.D. N.Y. 2011)(quoting In re Mado�, 2010 WL 3260074, *3 (S.D. N.Y. 2010)). For a discussionof the factors and applicable case law construing those factors see In re BernardL. Mado� Inv. Securities LLC, 2011 WL 3897970, *3–4 (S.D. N.Y. 2011).

258Id. at *2.

259As noted in section II.A. note 52 of this article, 11 U.S.C. § 546(e) provides

a “safe harbor” from recovery for certain recipients of, inter alia, constructivefraudulent transfers. The “safe harbor” does not apply to actually fraudulenttransfers. See Merkin I, 440 B.R. at 266–67.

260In seeking leave to appeal the bankruptcy court's order, the Funds raised

the following issues: (a) whether a complaint for actual fraud under section


1085

existed for a di�erence of opinion as to the correctness of thestandards relied upon by the bankruptcy court.

a. Transferee Intent Not Relevant to Allegations ofActual Fraudulent Transfer

The Funds contended that the complaint failed to allege factssu�cient to (a) connect the Funds to Mado�'s fraudulent schemeto defraud and (b) support allegations of the Funds' fraudulentintent as part of the trustee's claims alleging that payments tothe Funds were actually fraudulent. With respect to this conten-tion, the district court analyzed applicable precedent decidedunder both the Bankruptcy Code and Section 276 of New YorkState's Debtor Creditor Law (the “NYDCL”) and pointed out thatneither section 548(a)(1)(A) of the Bankruptcy Code nor the anal-ogous provision of the NYDCL261 requires proof of the transferee'sfraudulent intent in order to allege claims asserting actual fraud-ulent transfer.262 Rather, both provide that only the transferor'sfraudulent intent is relevant for pleading purposes.263 In thatregard, as noted by the district court, the requisite fraudulentintent on the part of BLMIS was satis�ed by the trustee's allega-

548(a)(1)(A) must allege facts su�cient to connect the defendant transferee tothe alleged scheme to defraud creditors; (b) whether, for purposes of allegingactual fraudulent transfer under section 548(a)(1)(A), certain claims aboutMado�'s non-transparent manner of operating BMLIS and Merkin's failure todisclose the full extent of his relationship with Mado� were su�cient to the es-tablish the transferee's fraudulent intent in accordance with the pleadingrequirements of Rule 9(b); (c) whether a complaint for actual fraudulent transferunder section 548(a) that fails to allege facts permitting an inference thatdefendants acted other than in good faith within the meaning of the defenseprovided by section 548(c) can withstand a motion to dismiss under Rule12(b)(6); (d) whether a Ponzi scheme investor who received transfers totalingless than his principal investment must forfeit his remaining principal basedupon a theory of constructive knowledge of the Ponzi scheme, absent a plea orproof of facts that who actual knowledge of, and participation by the investor inthat scheme; and (e) whether BMLIS was a stockbroker or �nancial institutionand were the payments it made pursuant to securities contracts so that the safeharbor of section 546(e) would preclude avoidance of any transfers on a construc-tive fraudulent transfer basis. In re Bernard L. Mado� Inv. Securities LLC,2011 WL 3897970, *3 (S.D. N.Y. 2011).

261See N.Y. Debtor and Creditor Law §§ 270 to 281 (McKinney 2001).

262In re Bernard L. Mado� Inv. Securities LLC, 2011 WL 3897970, *7–8

(S.D. N.Y. 2011).263

Id. at *4–5. The district observed that transferee intent is relevant underSection 278(1) of the NYDCL, which provides an a�rmative defense transfereeswho received conveyances for “fair consideration” and “without knowledge of thefraud,” and is an issue that should be considered on a full evidentiary record.Id. at *6.


1086

tions that the payments made by BLMIS to the Merkin Defen-dants were made in furtherance of Mado�'s Ponzi scheme pursu-ant to the “Ponzi Scheme Presumption.”264

b. Good Faith A�rmative Defense to Actual FraudulentTransfer

Merkin I held that the Merkin Defendants were not entitled todismissal of the actual fraudulent transfer claim pursuant to thea�rmative defense set forth in section 548(c) of the BankruptcyCode. That defense, as noted above, provides that transfersotherwise avoidable as fraudulent under section 548 of the Bank-ruptcy Code may not be avoided if made in exchange for valueand in good faith, to the extent of the value provided to the debtorin exchange for such transfer.265 In Merkin II, the district courtquickly determined that, on this issue, no substantial ground fordisputing the correctness of the standards applied by the bank-ruptcy court existed, noting that the bankruptcy court (a)

264Id. at *5. The “Ponzi Scheme Presumption” is a general rule that provides

that where a Ponzi scheme exists, all of the transfers made in furtherance ofthe scheme are presumed to have been made with the actual intent to hinder,delay and defraud creditors. Id. at *4; see also In re Bayou Group, LLC, 439B.R. 284, 294 (S.D. N.Y. 2010); In re Manhattan Inv. Fund Ltd., 397 B.R. 1, 8(S.D. N.Y. 2007); Drenis v. Haligiannis, 452 F. Supp. 2d 418, 429 (S.D. N.Y.2006). See generally In re AFI Holding, Inc., 525 F.3d at 704 (noting that the ex-istence of a Ponzi scheme is su�cient to establish actual intent to defraudunder § 548(a)(1)); Armstrong v. Collins, 2010 WL 1141158, *20 (S.D. N.Y.2010) (Ponzi scheme operators necessarily act with “actual intent to defraudcreditors due to the nature of their schemes”) (quoting Terry v. June, 432 F.Supp. 2d 635, 639 (W.D. Va. 2006)); Quilling v. Stark, 2006 WL 1683442, *6(N.D. Tex. 2006) (the existence of a Ponzi scheme makes the transfer of fundsfraudulent as a matter of law); Merkin I, 440 B.R. at 255 (“It is now wellrecognized that the existence of a Ponzi scheme establishes that transfers weremade with the intent to hinder, delay and defraud creditors”); In re 1031 TaxGroup, LLC, 439 B.R. 47, 72, 53 Bankr. Ct. Dec. (CRR) 180 (Bankr. S.D. N.Y.2010), subsequent determination, 439 B.R. 84, 53 Bankr. Ct. Dec. (CRR) 247(Bankr. S.D. N.Y. 2010) and opinion supplemented, 439 B.R. 78, 53 Bankr. Ct.Dec. (CRR) 246 (Bankr. S.D. N.Y. 2010) (noting that if the Ponzi schemepresumption applies, “actual intent for purposes of section 548(a)(1)(A) isestablished ‘as a matter of law.’ ”) (quoting In re Manhattan Inv. Fund Ltd., 397B.R. at 14); In re Rothstein Rosenfeldt Adler, P.A., 2010 WL 5173796, *5 (Bankr.S.D. Fla. 2010) (“bankruptcy courts nationwide have recognized that establish-ing the existence of a Ponzi scheme is su�cient to prove a Debtor's actual intentto defraud”) (quoting In re McCarn's Allstate Fin., Inc., 326 B.R. at 850); In reChristou, 2010 WL 4008167, *3 (Bankr. N.D. Ga. 2010) (stating that transfersmade during the course of a Ponzi scheme are “presumptively made with intentto defraud”).

265In re Bernard L. Mado� Inv. Securities LLC, 2011 WL 3897970, *8 n. 10

(S.D. N.Y. 2011) (quoting 11 U.S.C. § 548(c)).


1087

considered the possibility that the trustee could run the risk ofunintentionally “pleading himself out of court” if he were to al-lege facts that establish the a�rmative defense, and (b) found, tothe contrary, that the trustee had pleaded numerous allegationscalling into question the good faith of the Funds.266 The districtcourt further found that the trustee need not dispute the ele-ments of the Funds' good faith a�rmative defense in order tosurvive a motion to dismiss.267

c. Constructive Fraud—Reasonably Equivalent Value orFair Consideration

Merkin II also addressed the Funds' argument that the bank-ruptcy court should have dismissed for failure to state a claimthe trustee's claims alleging constructive fraudulent transferunder section 548(a)(1)(B) of the Bankruptcy Code becauseBLMIS received reasonably equivalent value for the transfersmade by the Funds. In this regard, in Merkin I, the Funds as-serted that, as investors in Mado�'s fraudulent scheme, theywere entitled to restitution for the principal amounts of theirinvestments and that such restitution claims constituted ante-cedent debt, the satisfaction (or reduction) of which constituted“value” to the debtor-transferor.268 The bankruptcy court heldthat the Merkin Defendants were not entitled to dismissal ofthese claims on the basis of the debtor's receipt of “reasonablyequivalent value” or “fair consideration” for purposes of section548(a)(1)(B) of the Bankruptcy Code or of the NYDCL, respec-tively, because the trustee had alleged su�cient facts indicating

266Id. at *8. The bankruptcy court did not address the standard for analyz-

ing “good faith” for purposes of § 548(c) of the Bankruptcy Code.267

Id. (citing In re Dreier LLP, 452 B.R. 391, 426 (Bankr. S.D. N.Y. 2011)).The bankruptcy court presiding over the Ponzi scheme bankruptcy case of thelaw �rm Dreier LLP held, inter alia, in analyzing the defendants/investors' mo-tions to dismiss that (i) a determination on the defendant's good faith defenseunder section 548(c) to claims asserting actual fraud was premature (but seem-ing to adopt a subjective standard requiring either conscious turning away fromfacts or dereliction of a duty to inquire where such a duty exists), (ii) the debtordid not receive reasonably equivalent value in exchange for payments to thedefendants that were in excess of principal, and (iii) the trustee could not re-cover payments of principal as constructively fraudulent transfers under NewYork Law, but that complaint stated claims for constructive fraudulent convey-ance under New York law with respect to payments made in excess of principalamount of bogus promissory notes. In re Dreier LLP, 452 B.R. 391 (Bankr. S.D.N.Y. 2011); see also In re Dreier LLP, 462 B.R. 474 (Bankr. S.D. N.Y. 2011)(holding similarly).

268In re Bernard L. Mado� Inv. Securities LLC;, 2011 WL 3897970, *9 (S.D.

N.Y. 2011).


1088

that the Funds invested in BLMIS with culpable knowledge ofthe fraudulent scheme, which, if proven, would demonstrate thatsuch transfers were not made in exchange for reasonably equiva-lent value under section 548(a)(1)(B) of the Bankruptcy Code orfor “fair consideration” pursuant to sections 273 to 275 of theNYDCL.269

The district court in Merkin II likewise rejected thesearguments. Noting that, under the Bankruptcy Code, whether atransfer was made in exchange for “reasonably equivalent value”is a fact-intensive inquiry and typically cannot be determined onthe pleadings,270 the district court distinguished Merkin I fromdecisions of other courts271 holding that a debtor receives reason-ably equivalent value in exchange for transfers to an investorthat do not exceed the principal amount of the investment, sothat only “false pro�ts” received by the investor are subject toclawback.272 The district court found these cases inappositebecause they did not involve transferees, like the Funds, who al-legedly invested in “bad faith,” and observed that the bankruptcy

269Id. This holding is contrary to a holding on the same issue decided in

Picard v. Katz published just a few weeks after the Merkin II decision was is-sued. See Picard v. Katz, 462 B.R. 447, 455–56, 55 Bankr. Ct. Dec. (CRR) 133,Bankr. L. Rep. (CCH) P 82077 (S.D. N.Y. 2011), motion to certify appeal denied,466 B.R. 208, 55 Bankr. Ct. Dec. (CRR) 266 (S.D. N.Y. 2012). Also, this holdingappears to add a lack of knowledge requirement that is not included in theplain language of the section 548(a)(1)(B).

270In re Bernard L. Mado� Inv. Securities LLC;, 2011 WL 3897970, *10

(S.D. N.Y. 2011).271

See, e.g., In re Carrozzella & Richardson, 286 B.R. 480, 487–88, 49 CollierBankr. Cas. 2d (MB) 1182 (D. Conn. 2002) (“[W]hen facing fraudulent convey-ance actions, investors may keep the principal amount of their investments, butthey may not keep any pro�ts from the scheme”) (citations omitted); In reChurchill Mortg. Inv. Corp., 256 B.R. 664, 682 (Bankr. S.D. N.Y. 2000), decisiona�'d, 264 B.R. 303, 46 Collier Bankr. Cas. 2d (MB) 851 (S.D. N.Y. 2001)(recognizing the “universally-accepted rule that investors may retain distribu-tions from an entity engaged in a Ponzi scheme to the extent of their invest-ments); see also In re Independent Clearing House Co., 77 B.R. 843, 857 (D.Utah 1987) (holding that payments that did not exceed the investor's principalinvestment were not avoidable under section 548(a)(2) because the debtorsreceived “reasonably equivalent value”).


N.Y. 2011). As noted above, the Eleventh Circuit in Haines adopted the ap-proach distinguished in Merkin I and II. The Haines decision was not cited byMerkin II. Also, as discussed infra, reasoning similar to that adopted in Haineswas adopted by the district court in Picard v. Katz, 462 B.R. 447, 55 Bankr. Ct.Dec. (CRR) 133, Bankr. L. Rep. (CCH) P 82077 (S.D. N.Y. 2011), motion tocertify appeal denied, 466 B.R. 208, 55 Bankr. Ct. Dec. (CRR) 266 (S.D. N.Y.2012).


1089

court found that the trustee had adequately pleaded facts allow-ing for the reasonable inference that the Funds knew or shouldhave known of Mado�'s fraud and helped to perpetrate it.273

In disposing of the Funds' similar arguments about thetrustee's constructive fraudulent conveyance claims under theNYDCL, the district court noted that the facts of the lone deci-sion cited by the Funds in support of their argument, Sharp Int'lCorp. v. State Street Bank and Trust Co.,274 were distinguishablefrom the facts in Merkin because it was undisputed that thetransferee's loan in Sharp ‘‘ ‘was made in good faith long beforethe purported fraudulent transfer.’ ”275 Unlike in Sharp, the bank-ruptcy court in Merkin I found plausible the trustee's allegationsthat the Funds knew of Mado�'s fraud at all relevant times. Thus,the district court found, “even if the Trustee were required to al-lege participation by the transferee in order to plead an absenceof good faith, the bankruptcy court found that the trustee satis-�ed [that] burden.”276

d. Constructive Fraud Claims—Section 546(e) SafeHarbor

In Merkin I, the bankruptcy court held that it was prematureto determine the applicability of the safe harbor included in sec-tion 546(e) of the Bankruptcy Code to the constructive fraudclaims against the Merkin Defendants when deciding a motion todismiss.277 In Merkin II, the Funds contended that they wereentitled to dismissal of the constructive fraudulent transferclaims because the a�rmative defense provided in section 546(e)of the Bankruptcy Code sheltered the transfers to the Fundsfrom avoidance because BLMIS was either a “stockbroker” or a“�nancial institution” and that the payments to the Funds were


N.Y. 2011) (quoting Merkin I, 440 B.R. at 262).274

Id. at *10 (citing In re Sharp Intern. Corp., 403 F.3d 43, 44 Bankr. Ct.Dec. (CRR) 146 (2d Cir. 2005) (“Sharp”)). In Sharp, the defendant bank made aloan to debtor, who then commenced a fraudulent scheme. Upon discovery ofthe debtor's possible fraud, defendant bank required immediate repayment ofthe loan. The trustee alleged that the loan's repayment was actually andconstructively fraudulent. The Second Circuit a�rmed the lower courts' dis-missal of complaint, holding that the defendant bank acted in good faith andthe trustee did not adequately plead actual fraud.

275In re Bernard L. Mado� Inv. Securities LLC;, 2011 WL 3897970, *10–11

(S.D. N.Y. 2011) (quoting Sharp, 403 F.3d at 55).276

Id. at *11.277

Merkin I, 440 B.R. at 266.


1090

made pursuant to “securities contracts.”278 The bankruptcy courtheld that it was premature to dismiss the constructive fraudclaims pursuant to section 546(e) because (a) it could not hold asmatter of law that BLMIS was a stockbroker engaged in thebusiness of e�ecting securities transactions279 because BLMIS al-legedly never purchased any securities and (b) it could not yetdetermine whether the account agreements governing the Funds'relationship with BLMIS were “securities contracts” for purposesof section 546(e).280 The district court found no substantialgrounds for a di�erence of opinion in this regard because theFunds had cited no decisions (a) where a Ponzi scheme operatorwho executed no trades was deemed at the pleading stage to be a“stockbroker” for purposes of section 546(e) of the BankruptcyCode and (b) in which an agreement was deemed to be a “securi-ties contract” for purposes of the Bankruptcy Code, where thatagreement (i) merely authorized one party to conduct futuretrades on behalf of another party, and (ii) did not by its terms ef-fect the purchase, sale or loan of a security between the parties.281

3. Picard v. Katz—A Shift to Subjective Good Faith andSection 546(e) Shelters Claims of Constructive FraudJust weeks after Judge Wood issued the Merkin II decision,

278Id. As noted above in note 52, supra, section 546(e) prevents the trustee

from avoiding transfers otherwise avoidable under sections 544, 545, 547,548(a)(1)(B) and 548(b) if “a transfer made by or to (or for the bene�t of) a . . .stockbroker . . . [or] �nancial institution . . . in connection with a securitiescontract.” 11 U.S.C. § 546(e). A “stockbroker” is a “person—(A) with respect towhich there is a customer . . . and (B) that is engaged in the business of e�ect-ing transactions in securities . . .” 11 U.S.C. § 101(53A). A “securities contract”is de�ned as, inter alia, “a contract for the purchase, sale, or loan of a security.”11 U.S.C. § 741(7)(A)(i) to (xi). The Funds contended that the alleged transfersfrom BLMIS were made by a stockbroker to a �nancial institution pursuant to asecurities contract, and accordingly could not be avoided. See Merkin I, 440 B.R.at 266.

279This holding is at odds with a holding in Picard v. Katz on the same is-

sue. See Picard v. Katz, 462 B.R. 447, 451–52, 55 Bankr. Ct. Dec. (CRR) 133,Bankr. L. Rep. (CCH) P 82077 (S.D. N.Y. 2011), motion to certify appeal denied,466 B.R. 208, 55 Bankr. Ct. Dec. (CRR) 266 (S.D. N.Y. 2012) (“Because Mado�Securities was a registered stockbrokerage �rm, all liabilities to customers aresubject to the safe harbor set forth in section 546(e) of the Bankruptcy Code”).


N.Y. 2011). Section 546(e) of the Bankruptcy Code relies on the de�nition of “se-curities contract” set forth in § 741(7) of the Bankruptcy Code. Section 741 ofthe Bankruptcy Code provides de�nitions applicable to Stockbroker Liquida-tions conducted under the Bankruptcy Code.


N.Y. 2011).


1091

and in contrast to that decision and the decision of the bank-ruptcy court in Merkin I, in the a�liated adversary proceeding ofPicard v. Katz,282 Judge Rako� of the United States District Courtfor the Southern District of New York283 granted the defendant-investors' motion to dismiss “all claims except those allegingactual fraud and equitable subordination and narrow[ed] thestandard for recovery under the remaining claims.”284 Accord-ingly, the district court dismissed the counts of the SIPA trustee'slengthy complaint against the defendants285 based on principlesof (a) preference and (b) constructive fraud under the BankruptcyCode and New York law, �nding that under the plain language ofsection 546(e) of the Bankruptcy Code, the defendants wereinsulated from avoidance by the safe harbor provided by thatsection.286 Although Picard v. Katz was settled on the eve of

282Picard v. Katz, 462 B.R. 447, 55 Bankr. Ct. Dec. (CRR) 133, Bankr. L.

Rep. (CCH) P 82077 (S.D. N.Y. 2011), motion to certify appeal denied, 466 B.R.208, 55 Bankr. Ct. Dec. (CRR) 266 (S.D. N.Y. 2012).

283This matter was before the United States District Court for the Southern

District of New York, rather than the United States Bankruptcy Court for theSouthern District of New York, where the underlying adversary proceeding was�led, because the reference of the adversary proceeding to the bankruptcy courtwas withdrawn. Id. at 450 n. 1.

284Id. at 450. As observed in note 259 of this article, the safe harbor does

not cover actually fraudulent transfers arising under section 548(a)(1)(A) of theBankruptcy Code.

285The defendants in Picard v. Katz include Fred Wilpon and Saul Katz, the

owners of the New York Mets.286

Picard v. Katz, 462 B.R. at 450. The dismissal of these claims waspremised upon the determination that the allegedly preferential or construc-tively fraudulent transfers were not avoidable as a matter of law pursuant tothe plain language of section 546(e) of the Bankruptcy Code, which contains asafe harbor for certain categories of transfers involving settlement payments ortransfers made in connection with securities contracts. As noted above, in thea�liated case of Picard v. Merkin, the bankruptcy court declined to make this�nding at the pleading stage. See section II.A. of this article for the completelanguage of section 546(e). While a detailed discussion of the applicability of thesection 546(e) safe harbor is beyond the scope of this article, it bears mentionthat in Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329, 55Bankr. Ct. Dec. (CRR) 12, 65 Collier Bankr. Cas. 2d (MB) 1833 (2d Cir. 2011),the Second Circuit examined the issue of whether section 546(e) of the Bank-ruptcy Code, which shields “settlement payments” from avoidance actions inbankruptcy cases, extends to an issuer's payments to redeem its commercialpaper prior to maturity. The Second Circuit in Enron Creditors Recovery Corp.held that the payments were protected because, among other reasons, the pay-ments completed a securities transaction, and thus quali�ed as “settlement pay-ments” as used in section 546(e) of the Bankruptcy Code. The Enron decisionwas also cited by the district court in Picard v. Katz for the same proposition in


1092

trial,287 as a result of the dismissal, the only claim for avoidancethat would have proceeded to trial in that case was the trustee'sclaim for actual fraud under section 548(a)(1)(A) of the Bank-ruptcy Code.288 In narrowing the standards for recovery, thedistrict court held that, as to the trustee's claims of actual fraudunder section 548(a)(1)(A) of the Bankruptcy Code, “the [t]rusteecan recover defendant's net pro�ts over the two years prior tobankruptcy simply by showing that the defendants failed toprovide value for those transfers, but the [t]rustee can recoverthe defendant's return of principle during that same period onlyby showing an absence of good faith on the defendants' part basedupon their willful blindness.”289 In issuing this decision, thedistrict court made certain legal �ndings with respect to the de-fenses under sections 546(e) and 548(c) of the Bankruptcy Codethat the bankruptcy court in Merkin I had deemed premature atpleading stage and that Judge Wood declined to review on an in-terlocutory basis.290

a. Section 546(e) Shelters Constructively Fraudulent andPreferential Transfers

The district court did not conduct an extensive analysis to

the context of denying the trustee's motion seeking leave to appeal the districtcourt's decision on the defendants' motion to dismiss. See 2012 WL 127397(S.D.N.Y. Jan. 17, 2012).

287See Memorandum of Understanding, Picard v. Katz, No. 11-cv-03605

(S.D.N.Y. March 19, 2012). On the eve of trial and as this article was beingcompleted, the parties in Picard v. Katz reached a settlement whereby thedefendants will pay the trustee $162 million, representing the �ctitious pro�tswithdrawn by the defendants over the 6-year period preceding the BLMISliquidation proceeding. As part of the settlement, the defendants' customerclaims will be allowed in full, and the recoveries from those claims will be fun-neled to the trustee to o�set the amount of the settlement payment.

288Just weeks before the trial scheduled for March 19, 2012, the district

court granted the trustee's motion for partial summary judgment, ordering thatthe trustee could recover pro�ts from the defendants that had been received inthe two years prior to the commencement of the liquidation in an amount not toexceed $83,309,162 because the defendants failed to show that the pro�ts hadbeen received for value. See Picard v. Katz, 2012 WL 691551 (S.D. N.Y. 2012);see also infra notes 307 & 308 and related text.

289Picard v. Katz, 462 B.R. at 455–56. The court further noted that the

burden of raising the good faith defense is initially on the defendants, but “thequestion of whether, once the defendants have made a prima facie showing ofgood faith, the burden shifts back to the Trustee to show lack of good faith, isan issue that need not be decided on this motion.” Id. at 456 n.9.

290Picard v. Katz does not mention the existence of evidence indicating that

the defendants in Picard v. Katz may have lacked good faith, as was the case inMerkin I.


1093

conclude that the safe harbor for transfers involving settlementpayments or transfers made in connection with securitiescontracts contained in section 546(e) of the Bankruptcy Codesheltered the allegedly preferential or constructively fraudulenttransfers from BLMIS to the defendants. Rather, the districtcourt looked to the plain language of section 546(e) and the re-lated provisions of the Bankruptcy Code291 and rejected the SIPAtrustee's suggestion to disregard the language of the statute,because following it would supposedly result in an outcome con-trary to the purpose of the statute.292 In making this determina-tion, the district court noted that, because BLMIS was aregistered stock brokerage �rm, the payments to its customers,such as the defendants, were subject to the safe harbor of section546(e).293 In addition to relying on the plain language of section546(e) of the Bankruptcy Code, the district court quoted from arecent decision from the Second Circuit Court of Appeals, In reEnron Creditors Recovery Corp., which observed that ‘‘ ‘[b]yrestricting a bankruptcy trustee's power to recover paymentsthat are otherwise avoidable under the Bankruptcy Code, thesafe harbor stands at the intersection of two important nationallegislative policies on a collision course—the policies of bank-ruptcy and securities law.’ ”294

b. Section 548(c) A�rmative Defense Applies Absent BadFaith and to the Extent of Value

After dismissing the trustee's preference and constructive fraudclaims, Judge Rako� turned his attention to the trustee's claimsalleging actual fraudulent transfer. Stating that it was “patent”that all of the transfers made by BLMIS during the two-year pe-riod preceding the �ling of liquidation proceedings were madewith the actual intent to defraud present and future creditorsbecause Mado�'s Ponzi scheme began more than two years before

291The district court noted that under section 741(7) of the Bankruptcy Code

a “securities contract” is a ‘‘ ‘contract for the purchase, sale or loan of a security,’which is the kind of contract [BLMIS] had with its customers.” Picard v. Katz,462 B.R. at 452. The district court observed that § 741(8) of the BankruptcyCode provides an extremely broad de�nition of “settlement payment” that wouldinclude all payments made by BLMIS to its customers. Id.

292Id. at 452. The district court also noted that a resort to the legislative

history was also inappropriate in this case where the language of the statutewas “plain and controlling on its face.” Id.

293Id. at 451.

294Id. (quoting Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651

F.3d 329, 334, 55 Bankr. Ct. Dec. (CRR) 12, 65 Collier Bankr. Cas. 2d (MB)1833 (2d Cir. 2011)).


1094

the �lings, the court explained that the issue before it was notwhether the transfers to the defendants could be avoided, butrather to what extent.295 Resolution of this issue, the districtcourt explained, turned on its application of the good faith andfor value defense set forth in section 548(c) of the BankruptcyCode.296 Thus, the district court ruled as a matter of law that tothe extent that a customer, in good faith, gave value to BLMIS inexchange for the transfers it received, it would be protected bysection 548(c) of the Bankruptcy Code.297 However, the avail-ability of that defense turned on whether the monies the trusteesought to recover were either the customers' principal or pro�ts.298

i. Subjective Lack of Good Faith for Ponzi Scheme Inves-tors

Concluding that it was “clear that the principal invested byany of Mado�'s customers ‘gave value to the debtor’ ”299 forpurposes of section 548(c), the district court held that principalinvested by the defendants could not be subject to recovery absenta showing of bad faith on the part of the defendants.300 To pleadthe defendants' bad faith, or lack of good faith, the trusteeadvanced two theories: �rst, that the customers received thefunds “willfully blind” of the underlying fraudulent scheme (i.e.that they ignored certain “red �ags” so as to secure short-termpro�t) or, in the alternative, that the defendants were on inquirynotice of the fraud but failed to diligently investigate BLMIS.301

The distinction between the two approaches was, essentially, thedi�erence between an objective (inquiry notice) versus a subjec-

295Id. at 453.

296Id. For the full text of section 548(c), see supra note 38.

297Picard v. Katz, 462 B. R. at 453.

298Id. Like the defendants in Merkin, the defendants in Picard v. Katz relied

on In re Sharp Intern. Corp., 403 F.3d 43, 54, 44 Bankr. Ct. Dec. (CRR) 146 (2dCir. 2005), in arguing that they should be entitled to keep amounts receivedfrom BLMIS in excess of principal. The district court rejected these arguments,noting that Sharp did not address actual fraudulent transfers. Id. at 453–54.The district court held that the defendants could only avail themselves of thea�rmative defense of section 548(c) to shelter transfers relating to pro�ts ifthey show not only that they took in good faith, but also for value, a showingthat the district court believed the defendants would have di�culty making.Picard v. Katz, 462 B. R. at 454 at n. 6.

299Picard v. Katz, 462 B. R. at 453 (quoting 11 U.S.C. § 548(c)).

300Id.

301Id. at 454–55 (citing In re Manhattan Inv. Fund Ltd., 397 B.R. 1, 22–23

(S.D. N.Y. 2007)).


1095

tive (willful blindness) standard.302 Although an objective stan-dard is often used in other bankruptcy contexts, given the stan-dards implemented in securities law fraud cases, the districtcourt determined that the subjective standard was more appropri-ate within the context of a SIPA liquidation.303 Thus, the districtcourt held that the trustee could only recover the defendants'return of principal by showing an absence of good faith ondefendants' part based on their “willful blindness.”304

In contrast, with respect to the recovery of “pro�ts” paid tocustomers by BLMIS, the district court concluded that pro�tswere likely subject to recovery by the trustee because such pro�tswere presumptively in excess of any value (principal) provided bythe customer, irrespective of a customer's good (or bad) faith.305

Thus, the only manner in which a defendant could preserve its

302Id. at 455.

303Id. Judge Rako� opined that the objective standard was not applicable in

the securities law context because, inter alia, a securities investor “has noinherent duty to inquire about his stockbroker” and that “a lack of due diligencecannot be equated with a lack of good faith, at least so far as section 548(c) isconcerned.” Id. Judge Glenn of the United States Bankruptcy Court for theSouthern District of New York employed a similar theory in his opinion in In reDreier LLP, where he distinguished the district court's decision in In re Manhat-tan Inv. Fund Ltd., 397 B.R. 1 (S.D. N.Y. 2007), and found that it was prematureto rule on the merits of the defendant's good faith defense under section 548(c)of the Bankruptcy Code but indicated that the objective standard would not ap-ply to the Dreier defendant because it, unlike the defendant in the ManhattanInv. Fund case, did not owe a duty to anyone other than its own investors toinvestigate Marc Dreier's fraudulent scheme. In re Dreier LLP, 452 B.R. 391,449 (Bankr. S.D. N.Y. 2011); see also In re Dreier LLP, 462 B.R. 474 (Bankr.S.D. N.Y. 2011) (holding similarly).

304Picard v. Katz, 462 B.R. at 455–56.

305Id. “In other words, while as to payments received by the defendants

from [BLMIS] equal to a return on their principal, defendants can defeat theTrustee's claim of actual fraud by simply proving their good faith, as to the pay-ments received by the defendants in excess of their principal, defendants candefeat the Trustee's claim of actual fraud only by showing that they not onlywere proceeding in good faith but also that they took for value.” Id. The districtcourt rejected the defendant's arguments that they should be entitled to resistavoidance of transfers relating to the pro�ts re�ected in the BLMIS monthlystatements, as long as they acted in good faith, �nding misplaced the defendants'reliance on the Sharp decision, which held that a conveyance which satis�es anantecedent debt made while a debtor is insolvent was neither fraudulent norimproper because the court in the Sharp case did not apply that holding toactually fraudulent transfers, but instead found that actual fraud had not beenadequately alleged. Id. at 454 (citing Sharp, 403 F.3d at 54, 56). The districtcourt found that a prima facie case for actual fraud was adequately pleaded andthat Sharp in no way controlled whether defendants could avail themselves ofthe “good faith” defense of section 548(c). Id.


1096

pro�ts would be if it were able to show that it provided value inexcess of its principal investment, which the court found washighly unlikely.306

Consistent with this decision, just weeks before the scheduledtrial, Judge Rako� granted the trustee's motion for partial sum-mary judgment, ordering that the trustee could avoid and recoverthe transfers from the defendant/investors representing pro�tsreceived during the two years prior to the commencement of theliquidation cases in an amount not to exceed $83,309,162 becausethe defendants failed to show that their pro�ts had been receivedfor value. In so ordering, the district court “concluded that the‘value’ the defendants gave to [BLMIS]—and therefore theamount that they received from [BLMIS] during the applicabletwo-year period that they can withhold from the Trustee under§ 548(c) unless the Trustee shows bad faith—is equal to theamount of their investment.”307 The district court further observedthat “the principal issue remaining for trial is whether thedefendants acted in good faith when they invested in [BLMIS] inthe two years prior to bankruptcy or whether, by contrast, theywillfully blinded themselves to Mado�'s Ponzi scheme.”308

The Picard v. Katz decision is a landmark in the BLMISliquidation because of its clear determinations on the applicabil-ity of the safe harbor provisions provided by sections 548(c) and546(e) of the Bankruptcy Code within the context of stockbrokerliquidations. Picard v. Katz demonstrates how those safe harborscan limit a trustee's avoidance powers when bankruptcy and se-curities laws are inconsistent.309

The Ponzi scheme decisions discussed in this article reveal a

306Id.

307Picard v. Katz, 2012 WL 691551, *1 (S.D. N.Y. 2012).

308Id. at *2. Judge Rako� expressed doubt that the trustee would be able to

rebut the defendants' showing of good faith. Id. at *1.309

While no longer particularly relevant in light of the settlement, early in2012, Judge Rako� denied the trustee's motion seeking certi�cation of the threekey rulings of the district court's September 2011 decision for interlocutory ap-peal. Picard v. Katz, 466 B.R. 208, 55 Bankr. Ct. Dec. (CRR) 266 (S.D. N.Y.2012). Amazingly, in this decision Judge Rako� states that he was unaware ofJudge Woods's Merkin II decision when he issued his September opinion inPicard v. Katz. Id. at *5. The main focus of decision was the SIPA trustee's ef-forts to introduce new arguments relating to § 546(e) in order to show asubstantial ground for di�erence of opinion for purposes of satisfying therequirements of 28 U.S.C. § 1292(b). Interestingly, however, Judge Rako� cor-rected his initial ruling dismissing Count 9 of the trustee's Amended Complaintwhich sought recovery from subsequent transferees pursuant to sections 544(b)and 550(a) of the Bankruptcy Code, and clari�ed that, to the extent a transfer


1097

number of trends. Haines, Picard v. Katz and In re Dreier LLPcon�rm that investors may retain transfers representing a returnof principal so long as such transfers were received in good faith.Among other things, Merkin I and Merkin II provide that thenature of the transferee may be relevant to whether a restitutionclaim may be asserted for purposes of demonstrating reasonablyequivalent value in response to claims asserting constructivefraud. Further, while the Merkin I and II decisions suggest thatthe safe harbor of section 546(e) may not apply in Ponzi schemecases regardless of whether the scheme is run through a fund ora broker-dealer, those decisions must now be read in light of thedecisions in the related case of Picard v. Katz, which determinedthat the trustee's claims for constructive fraud were subject todismissal because the safe harbor of section 546(e) applied toBLMIS as a stockbroker. Given the amounts at stake and theseholdings within the Southern District of New York in the BLMISliquidation, future decisions on these issues are likely. ShouldMerkin I ultimately withstand appeal, the powers of trustees inthis regard will be strengthened signi�cantly, making, in thecase of BLMIS, the reallocation of assets to investors more likely.Investors who are deemed to have knowledge or who investthrough non-innocent investors in a Ponzi scheme may berequired to relinquish transfers representing principal invest-ments, in addition to those for �ctitious pro�ts.

C. Defenses to Liability for Recovery for AvoidedTransfers Pursuant to Section 550 of the BankruptcyCode

During 2011 the assertion of defenses and exceptions to li-ability for avoided fraudulent transfers under section 550 of theBankruptcy Code310 continued311 to result in noteworthy decisions,both with respect to the determination of (a) who is either a

to an initial transferee could have been avoided under section 548(a)(1)(A) ofthe Bankruptcy Code, the trustee could avoid to the same extent subsequenttransfers of the same funds under section 550(a). The district court reinstatedCount 9 “insofar as it [sought] to avoid subsequent transfers under § 550(a)wherever the Trustee could have avoided an initial transfer under 548(a)(1)(A).”Id. at *6.

310The full text of section 550 of the Bankruptcy Code and its background is

provided at section II.B. of this article.311

The 2011 edition of this article included a discussion of the SeventhCircuit's opinion in Paloian v. LaSalle Bank, N.A., 619 F.3d 688, 53 Bankr. Ct.Dec. (CRR) 155, Bankr. L. Rep. (CCH) P 81840 (7th Cir. 2010), which held thatthe bankruptcy trustee could seek to recover avoidable payments from thedebtor to LaSalle Bank, the trustee for a securitized pool of loans which included


1098

“mere conduit” or an initial transferee who is otherwise exceptedfrom liability under section 550(a)(1)312 of the Bankruptcy Codeand (b) the standards for analyzing the a�rmative defense forsubsequent transferees who took for value and in good faith undersection 550(b)313 of the Bankruptcy Code.314

1. Developments in the Mere Conduit Defense to InitialTransferee LiabilityAs a general rule, section 550(a) of the Bankruptcy Code

provides for strict liability of initial transferees for transfersavoidable under section 548 of the Bankruptcy Code. However, a“mere conduit” of such transfers, who lacks control over theultimate disposition of the funds or assets transferred, is typi-cally not liable for recovery as an “initial transferee” or an entity“for whose bene�t” an avoided transfer was made for recoverypursuant to section 550(a) of the Bankruptcy Code. Recently the

a note from the debtor. See Gallagher, supra note 24. The basis for recovery inPaloian was the assertion that LaSalle Bank was an “initial transferee” of thepayments for purposes of section 550(a)(1) of the Bankruptcy Code becauseLaSalle Bank was the legal owner of the trust. In Paloian, the funds at issuewere paid into trust for the bene�t of the investors and distributed by LaSalleBank pursuant to the parties' trust agreement. While LaSalle Bank argued thatit was a “mere conduit” and compared itself to a bank holding money in a check-ing account for a customer, the Seventh Circuit's concluded that a trustee to asecuritized trust may be an “initial transferee” for purposes of section 550(a).This decision has important implications for entities serving in similar trusteeroles, as well as for investors in “bankruptcy-remote” products. While theSeventh Circuit concluded that LaSalle Bank, as trustee, could make anyrequired payments to a bankruptcy estate from the corpus of the trust, presum-ably without damage to itself, this does not resolve the con�ict faced by trusteesto securitized trusts who are contractually bound to transfer funds to the trustinvestors and have no bene�cial interest in such funds. As discussed infra, thepotential impact of Paloian is considerable. If the trustee of a securitized pool isan “initial transferee,” that trustee cannot avail itself of the good-faith defensea�orded by section 550(b)—a defense to recovery that only is available to agood-faith transferee other than the “initial transferee” or an “entity for whosebene�t [the fraudulent] transfer was made.” Because the Seventh Circuitrecognized that the trust's investors are “the persons for whose bene�t” thetransfers are made for purposes of section 550(a), those investors are similarlyunable to rely on the section 550(b) good-faith defense.

312Section 550(a) generally provides that avoided transfers may be recovered

from initial transferees, recipients from initial transferees, and any entity forwhose bene�t the transfers were made. 11 U.S.C. § 550(a).

313Essentially, section 550(b) provides a defense to subsequent transferees

of avoided transfers who took in good faith, for value and without knowledge ofthe voidability of the transfer avoided. 11 U.S.C. § 550(b).

314This topic was also a signi�cant issue in TOUSA I and TOUSA II and is

discussed at length in section III.A. of this article.


1099

“mere conduit” theory for escaping liability for avoided transfershas generated some interesting, but not entirely consistent,decisions.

a. The Eleventh Circuit Adds a Good Faith RequirementThe Eleventh Circuit Court of Appeals in Martinez v. Hutton

(In re Harwell)315 recently examined the mere conduit defense toinitial transferee liability for avoidable transfers. It determinedthat, in order to successfully invoke the mere conduit defenseand avoid liability for recovery of fraudulent transfers pursuantto section 550(a)(1) of the Bankruptcy Code, the transferee musthave acted in good faith. The Eleventh Circuit reversed (a) thetrial court's grant of summary judgment to the defendant basedon the determination that he was not an initial transferee and (b)the district court's a�rmance of that decision,316 and held that anattorney, allegedly the “mastermind” of his client's fraudulenttransfers through such attorney's law �rm trust account, could bean initial transferee upon a showing of the attorney's lack of goodfaith.317 Only the Fourth Circuit has held similarly.318 The othercircuits have declined to �nd a good faith requirement for mereconduits.319

In Harwell, the trustee appointed in the Chapter 7 case of BillyJason Harwell (“BJH”) commenced a fraudulent transfer actionin the bankruptcy court against BJH's lawyer (“Hutton”), alleg-ing that Hutton accepted proceeds of settlements on BJH's behalfand then disbursed those funds to BJH, BJH's family membersand selected creditors, as directed by BJH.320 Hutton acceptedand transferred BJH's settlement proceeds with knowledge of ajudgment creditor's substantial e�orts to collect against BJH's

315In re Harwell, 628 F.3d 1312, 54 Bankr. Ct. Dec. (CRR) 12, 64 Collier

Bankr. Cas. 2d (MB) 1820, Bankr. L. Rep. (CCH) P 81909 (11th Cir. 2010)(“Harwell”).

316Id. at 1314, 1324.

317Id. at 1323, 1324.

318See In re Harbour, 845 F.2d 1254, 18 Collier Bankr. Cas. 2d (MB) 1214,

Bankr. L. Rep. (CCH) P 72308, 92 A.L.R. Fed. 621 (4th Cir. 1988) (“In reHarbour”).

319See, e.g., In re Finley, Kumble, Wagner, Heine, Underberg, Manley,

Myerson & Casey, 130 F.3d 52, 31 Bankr. Ct. Dec. (CRR) 978, 38 Collier Bankr.Cas. 2d (MB) 1851, Bankr. L. Rep. (CCH) P 77560 (2d Cir. 1997); BondedFinancial Services, Inc. v. European American Bank, 838 F.2d 890, 17 Bankr.Ct. Dec. (CRR) 299, 18 Collier Bankr. Cas. 2d (MB) 155 (7th Cir. 1988) (“BondedFinancial”).

320Harwell, 628 F.3d at 1316.


1100

assets. Those e�orts included obtaining a turnover order and awrit of garnishment for the subject settlement funds, which wasserved upon Hutton.321 A few weeks after the transfers from Hut-ton's trust account, BJH �led for protection under the Bank-ruptcy Code.

Prior to BJH's bankruptcy �ling, a creditor obtained a judg-ment against BJH in the amount of $1.4 million.322 Around thesame time, Hutton represented BJH in negotiating settlements ofunrelated business disputes, settlements that resulted in pay-ments to BJH totaling just over $500,000. Pursuant to BJH'ssettlement agreements, the proceeds of the settlements were �rstdeposited into Hutton's client trust account, then, in accordancewith BJH's instructions, were disbursed by Hutton to BJH,certain of BJH's family members, and selected creditors of BJH.None of these funds were paid to the judgment creditor.323

In the litigation before the bankruptcy court, the Chapter 7trustee sought to avoid the transfers of BJH's settlement proceedsto Hutton under section 548 of the Bankruptcy Code and recoverfrom Hutton pursuant to section 550(a). Hutton moved for sum-mary judgment,324 arguing that he was not an initial transferee ofthe settlement proceeds because he did not have dominion orcontrol over the funds because they were kept in and disbursedthrough his attorney trust account.325 For purposes of the sum-mary judgment ruling, the bankruptcy court expressly assumedthat (1) ‘‘ ‘Hutton was the mastermind . . . that was driving allthe pieces of what was a huge fraudulent conveyance of hundredsof thousands of dollars that would have been [otherwise] avail-able for creditors,’ and (2) that Hutton ‘managed to coordinatethings in a fashion that the settlement was concluded and themoney funneled through Mr. Hutton's trust account to variouspreferred creditors and insiders in either preferential or fraudu-lent transfers.’ ”326 Nonetheless, the bankruptcy court grantedHutton's motion for summary judgment, determining that Hut-

321Id. at 1315.

322Id. at 1314.

323Id.

324The appeal arose from Hutton's motion for summary judgment and,

therefore, for purposes of its summary judgment ruling, the bankruptcy courtviewed the facts and drew inferences in a light most favorable to the non-moving party, i.e. the Chapter 7 trustee in the Harwell bankruptcy case. Id. at1316–17.

325Id. at 1316.

326Id.


1101

ton was not an initial transferee of BJH's funds under section550(a)(1) of the Bankruptcy Code because Hutton never haddominion and control over the money kept for BJH in the trustaccount. This ruling prevented the Chapter 7 trustee fromrecovering the fraudulently transferred funds from Hutton.327

The district court a�rmed the bankruptcy court's decision,328

concluding that the Eleventh Circuit's discussion in In re Int'lAdmin. Svcs., Inc. of a good faith requirement for reliance on themere conduit exception was dicta.329 The district court held thatHutton had acted as a �duciary and was obligated to disbursethe funds from his trust account according to his client'sinstructions.330 As a result, the district court found that Huttonexercised no control over the funds, as is required for initialtransferee liability under section 550(a)(1) of the BankruptcyCode.331

The main issue on appeal to the Eleventh Circuit was whetherHutton was an initial transferee for the purpose of section550(a)(1) of the Bankruptcy Code. If Hutton were an initialtransferee, the Chapter 7 trustee could recover from Hutton the$500,000 placed in Hutton's trust account and distributed pursu-ant to BJH's instructions.332 The Eleventh Circuit began its anal-ysis by observing that the term “transferee” is not de�ned in theBankruptcy Code.333 It then conducted a thorough review of itsearlier precedent addressing the mere conduit exception to li-ability of initial transferees and described the genesis anddevelopment of the control test it �rst articulated in Nordberg v.

327Id.

328Id.; see In re Harwell, 414 B.R. 770, 785 (M.D. Fla. 2009).

329In re Harwell, 414 B.R. at 779; see In re International Administrative

Services, Inc., 408 F.3d 689, 705, 44 Bankr. Ct. Dec. (CRR) 178, Bankr. L. Rep.(CCH) P 80279 (11th Cir. 2005) (“In order for this exception to apply . . . wemust determine whether [defendants] are merely conduits of the IAS funds, andwhether IBT and SCSD are the resulting ‘initial transferees.’ As we read it, theconduit rule presumes that the facilitator of funds acts without bad faith, and issimply an innocent participant to the underlying fraud.”).

330In re Harwell, 414 B.R. at 785.

331Harwell, 628 F.3d at 1316; In re Harwell, 414 B.R. at 785.

332Harwell, 628 F.3d at 1317. The Eleventh Court reviewed the bankruptcy

court's factual determinations for clear error and its legal determinations denovo. Id. at 1316–17.

333Id. at 1317.


1102

Sanchez (In re Chase & Sanborn),334 a fraudulent transfer actionwhere the relevant issue was whether the funds transferred inand out of the debtor's bank account were property of the debtorthat could be recovered from the bank.335

After a detailed review of the relevant Eleventh Circuit prece-dent addressing the control test and the term “mere conduit” forpurposes of determining initial transferee liability within theEleventh Circuit,336 the circuit found that “a clear pattern

334Id. at 1317–18 (citing In re Chase & Sanborn Corp., 813 F.2d 1177, Bankr.

L. Rep. (CCH) P 71753 (11th Cir. 1987) (“Chase & Sanborn I”)).335

Id. at 1318. Chase & Sanborn I did not address initial transferee li-ability; rather, it dealt with whether funds that were fraudulently transferredwere the debtor's property for purposes of section 548 of the Bankruptcy Codeand determined that the debtor did not have su�cient control over the subjectfunds in its bank account for those funds to be considered property of the debtor.813 F.2d at 1178–82.

336See Harwell, 628 F.3d at 1317–23. The remainder of this footnote

describes that review. In Chase & Sanborn I, the circuit held that, in view ofthe entire circumstances of the transaction, where funds were placed by a thirdparty into the debtor's account, but the debtor did not have control over the dis-position of the funds, the funds were not the debtor's property and the transferwas not avoidable under section 548. 813 F.2d at 1182. In In re Chase &Sanborn Corp., 848 F.2d 1196, Bankr. L. Rep. (CCH) P 72363 (11th Cir. 1988)(“Chase & Sanborn II”), the circuit held that while the defendant bank hadreceived the funds from the debtor, technically making it an “initial transferee,”it would be inequitable to allow recovery where the defendant bank had nocontrol over the funds. Harwell, 628 F.3d at 1319. The court in Chase & SanbornII distinguished the deposit at issue from one where a debtor transfers moneyto a bank to repay a loan or other debt to the bank. Harwell, 628 F.3d at 1319(quoting Chase & Sanborn II at 1200). The Eleventh Circuit in Harwell notedthat in In re International Administrative Services, Inc., 408 F.3d 689, 44 Bankr.Ct. Dec. (CRR) 178, Bankr. L. Rep. (CCH) P 80279 (11th Cir. 2005), it observedthat a mere conduit cannot be considered an initial recipient for purposes of anavoidance action, and held that the defendants in the Int'l Admin. Svcs., Inc.case did not lack knowledge of the fraud as required by the mere conduitexception. 628 F.3d at 1320–21 (quoting 408 F.3d at 705: “As we read it, theconduit rule presumes that the facilitator of funds acts without bad faith, and issimply an innocent participant to the underlying fraud”). The Int'l Admin.Svcs., Inc. decision addressed the “good faith” issue and recognized that, in or-der to be a mere conduit, the recipient must have acted in good faith. 408 F.3dat 705. Finally, the Eleventh Circuit in Harwell reviewed its decision in In rePony Exp. Delivery Services, Inc., 440 F.3d 1296, 46 Bankr. Ct. Dec. (CRR) 24,Bankr. L. Rep. (CCH) P 80465 (11th Cir. 2006), in which it held that an insur-ance broker who held a debtor's deposit to cover insurance premiums did notexercise legal control over the funds and was not an initial transferee. 628 F.3dat 1321–22. The Eleventh Circuit in Harwell observed that in Pony Express ithad noted that the mere conduit test takes on special signi�cance when thetransferee is ‘‘ ‘duty-bound to take only limited actions with respect to the funds


1103

emerged.”337 First, the circuit found that an initial transferee forpurposes of section 550(a) of the Bankruptcy Code quite literallymeans the initial recipient of a debtor's fraudulently transferredfunds.338 Second, the Eleventh Circuit observed that it had carvedout an equitable exception to the literal statutory language ofinitial transferee through the mere conduit or control tests.339 Ac-cording to the Eleventh Circuit, the mere conduit or control de-fenses provide equitable exceptions to strict liability for an initialtransferee's fraudulent transfers because it would be inequitableto hold an initial recipient of a fraudulent transfer liable wheresuch recipient “could not ascertain the transferor debtor'ssolvency, or lacked any control over the funds, or lacked knowl-edge of the source of the funds.”340 Third, the Eleventh Circuitobserved that “[t]he conduit or control test is based on, andde�ned by, equity and requires good faith to escape ‘initialtransferee’ liability. In e�ect, we have tempered literal applica-tion of section 550(a)(1), examining all of the facts and circum-stances surrounding a transaction to prevent recovery from atransferee innocent of wrongdoing and deserving of protection.”341

The Eleventh Circuit concluded that in order to rely upon themere conduit or control theory for escaping liability, a defendantmust make a showing of good faith,342 stating:

[G]ood faith is a requirement under this Circuit's mere conduit orcontrol test. Accordingly, initial recipients of the debtor's fraudu-lently transferred funds who seek to take advantage of the equita-ble exceptions to § 550(a)(1)'s statutory language must establish (1)that they did not have control over the assets, i.e. that they merelyserved as a conduit for the assets that were under the actual control

received’. . . Often these �duciaries or agents are not considered initialtransferees because their legal control over the assets received is circumscribedby their legal duties to their clients.’ ” Id. at 1321 (quoting Pony Express, 440F.3d at 1300–1).

337Harwell, 628 F.3d at 1322.

338Id. This is not a uniformly adopted view, as several courts have found

that a mere conduit is not an initial transferee. See section III.C.3.b. of thisarticle.

339Harwell, 628 F.3d at 1322 (emphasis added).

340Id. (citing Chase & Sanborn II, 848 F.2d at 1199–1202).

341Id. at 1322–23.

342Id. at 1323.


1104

of the debtor-transferor and (2) that they acted in good faith as aninnocent participant in the fraudulent transfer.343

The Eleventh Circuit dismissed Hutton's argument that thegood faith principle discussed in In re Int'l Admin. Svcs., Inc. wasonly dicta, and held “explicitly . . . that good faith is a require-ment under this Circuit's mere conduit or control test.”344 Itconcluded that Hutton was an initial transferee for purposes ofsection 550(a) of the Bankruptcy Code because he was the initialrecipient of the debtor's funds from the settlements, an issue thatHutton did not dispute.345 Upon resolving his business disputes,BJH had the settlement proceeds sent to Hutton. Even thoughHutton quickly sent the funds to subsequent transferees, he un-questionably received them and deposited them into his trustaccount. As a result, “Hutton was the initial recipient of thefunds, and thus the ‘initial transferee’ under the language of§ 550(a)(1).”346

Because the bankruptcy court had only assumed for purposesof the summary judgment motion that Hutton was the master-mind of the debtor's scheme to fraudulently funnel the debtor-client's money into and out of Hutton's trust account, theEleventh Circuit determined that triable issues of fact precludedsummary judgment on Hutton's assertion of the “mere conduit”or “control defense.”347 Accordingly, the Eleventh Circuit re-manded the case to the bankruptcy court for further �ndings onwhether Hutton had acted in good or bad faith.348

On remand, the bankruptcy court found that Hutton had notacted in good faith and was not entitled to rely upon the mereconduit exception to initial transferee liability under section550(a)(1) of the Bankruptcy Code.349 The bankruptcy court inHarwell II observed that Hutton, as a Florida attorney, had nodiscretion in choosing the recipients of the money that BJHdirected to Hutton's trust account since attorneys are bound to

343Id. In reaching this conclusion, the Eleventh Circuit also relied upon the

Fourth Circuit's decision in In re Harbour, 845 F.2d 1254, 1258, 18 CollierBankr. Cas. 2d (MB) 1214, Bankr. L. Rep. (CCH) P 72308, 92 A.L.R. Fed. 621(4th Cir. 1988).

344Harwell, 628 F.3d at 1323 n.10.

345Id. at 1323–24.

346Id. at 1324.

347Id.

348Id.

349In re Harwell, 2011 WL 4566443, *4 (Bankr. M.D. Fla. 2011) (“Harwell

II”).


1105

follow the instructions of their clients in distributing trust funds.Nonetheless, Hutton was not required to make his trust accountavailable to BJH so that BJH could e�ect intentionally fraudu-lent transfers.350 Since Hutton was aware that BJH was activelyseeking to shelter the settlement proceeds from his judgmentcreditor's collection e�orts, Hutton could have (and should have)refused to receive the settlement proceeds and insisted that thesettlement agreements not make him the recipient of thosefunds.351 Hutton also could have transferred the funds to BJH,rather than facilitating BJH's e�orts to remove the funds fromthe reach of his judgment creditor.352 The bankruptcy court madeclear that this was not the case “of a bank, or for that matter anattorney, being unwittingly involved as the initial transferee offunds used as part of a scheme to defraud creditors under cir-cumstances that would put the bank or attorney on notice of theintent to hinder or delay a creditor.”353 Because Hutton failed toshow that he had acted in good faith and was an innocent partic-ipant in BJH's actions to hinder and delay his creditors, the bank-ruptcy court in Harwell II held that Hutton was liable as theinitial transferee of BJH's funds.354

In Harwell, the Eleventh Circuit adopted a literal interpreta-tion of the term “initial transferee” in section 550(a)(1) of theBankruptcy Code. Unlike the jurisdictions which have determinedthat a mere conduit is not an initial transferee,355 the EleventhCircuit has carved out an equitable exception to the literal statu-

350Id. at *7.

351Id. at *6.

352The evidence also showed that Hutton had sought legal counsel to advise

him of his obligations with respect to the settlement proceeds, but that advicewas limited to Hutton's obligations as a holder of garnished funds. The courtthen explored whether missing the fraudulent transfer legal issue was su�cientto support a �nding that Hutton acted in good faith and was an innocent partic-ipant in the fraudulent transfer. Id. at *7.

353Id.

354Id. at *10.

355See, e.g., In re Incomnet, Inc., 463 F.3d 1064, 47 Bankr. Ct. Dec. (CRR)

23, Bankr. L. Rep. (CCH) P 80717 (9th Cir. 2006) (applying the Bonded Financialdominion test and �nding that the federal agency that collected funds as theadministrator of an FCC trust had legal dominion over the funds and, thus, wasan initial transferee); In re Hurtado, 342 F.3d 528, 41 Bankr. Ct. Dec. (CRR)229, Bankr. L. Rep. (CCH) P 78904, 2003 FED App. 0312P (6th Cir. 2003) (ap-plying the Bonded Financial dominion test and �nding that a family memberwho held debtors' funds in her personal savings account and thus had legalcontrol over said funds was the initial transferee); In re Finley, Kumble, Wagner,Heine, Underberg, Manley, Myerson & Casey, 130 F.3d 52, 31 Bankr. Ct. Dec.


1106

tory language of section 550(a) for entities with no control overthe fraudulently transferred funds and imposed a good faithrequirement even though there is no mention of good faith in sec-tion 550(a)(1). The Eleventh Circuit relied on the plain languageof the statute to �nd strict liability for initial recipients whileadding a good faith requirement not expressly included in thestatute.356

b. Trends in Mere Conduit Exception to InitialTransferee Liability

The 2011 edition of this article discussed the Seventh CircuitCourt of Appeals' decision in Paloian v. Lasalle Bank N.A.,357

where the Seventh Circuit determined that the trustee to a

(CRR) 978, 38 Collier Bankr. Cas. 2d (MB) 1851, Bankr. L. Rep. (CCH) P 77560(2d Cir. 1997) (applying Bonded Financial dominion test); In re Southeast HotelProperties Ltd. Partnership, 99 F.3d 151, 29 Bankr. Ct. Dec. (CRR) 1202, 36Collier Bankr. Cas. 2d (MB) 1649, Bankr. L. Rep. (CCH) P 77158 (4th Cir. 1996)(applying legal dominion test and holding that creditor, rather than agent ofdebtor, was the initial transferee of funds received from debtor's agent); In reFirst Sec. Mortg. Co., 33 F.3d 42, 25 Bankr. Ct. Dec. (CRR) 1683, Bankr. L. Rep.(CCH) P 76046 (10th Cir. 1994) (applying the dominion test articulated inBonded Financial and �nding that bank was not the initial transferee of fundsdeposited in attorney trust account); Matter of Coutee, 984 F.2d 138, 28 CollierBankr. Cas. 2d (MB) 762, Bankr. L. Rep. (CCH) P 75112 (5th Cir. 1993) (apply-ing legal dominion or control test similar to test applied in Bonded Financialand holding that creditor bank was the initial transferee of funds used to repayloan, even though funds were �rst deposited into attorney trust account, becauseholders of attorney trust account did not have legal dominion or control over thefunds held solely in a �duciary capacity); In re Anton Noll, Inc., 277 B.R. 875,39 Bankr. Ct. Dec. (CRR) 353, 47 U.C.C. Rep. Serv. 2d 1393, 89 A.F.T.R.2d2002-2672 (B.A.P. 1st Cir. 2002) (applying a combination of the Bonded Finan-cial dominion and the Chase & Sanborn control tests to �nd that debtor'sprincipal who converted cash from the debtor and used it to pay the IRS wasthe initial transferee, rather than the IRS, despite minimal time lapse betweencash conversion and payment).

356Interestingly, Congress can and has speci�cally added good faith require-

ments to the Bankruptcy Code, including the good faith requirement containedin section 550(b), which limits a subsequent transferee's liability for avoidedtransfers. As noted in section II.A. of this article, the good faith exception tofraudulent transfer avoidance under 11 U.S.C. 548(c) applies only to transfersavoided under section 548 and, unlike section 550(b), requires that value beprovided to the debtor. Section 550(b) prevents subsequent transferees fromrecovery for avoided transfers if they have taken for value, in good faith, andwithout knowledge of the voidability of the transfer. See section III.C.2. of thisarticle for a discussion of good faith under section 550(b) of the BankruptcyCode.

357Paloian v. LaSalle Bank, N.A., 619 F.3d 688, 53 Bankr. Ct. Dec. (CRR)

155, Bankr. L. Rep. (CCH) P 81840 (7th Cir. 2010). See Gallagher, supra note24.


1107

securitized pool of loans, LaSalle Bank (“LaSalle”), could be liableas the initial transferee of transfers made by a debtor hospitalthrough MMA Funding LLC (“MMA”), an entity that wasintended to be bankruptcy remote.358 In Paloian, a loan was madeto the hospital that was subsequently sold and securitized.359 Thenotes and interests related to the loan were transferred to asecuritized trust, of which LaSalle was the trustee.360 MMA madesome payments on the loan to LaSalle on behalf of the hospital.361

In Paloian the Seventh Circuit rejected LaSalle's argumentsthat it was a mere conduit and held that LaSalle, as trustee, wasthe legal owner of the securitization trust's assets, and the initialtransferee for purposes of an avoidance action to recover certainpayments on the loan made to the trust, even though LaSallelacked control over disbursement of the funds.362 The SeventhCircuit determined that LaSalle's contractual obligations todisburse the funds to the trust certi�cate holders of the trust didnot conclusively establish LaSalle's mere conduit status.363 Inreaching this conclusion the Seventh Circuit relied on the hold-ing of Bonded Financial364 for the proposition that LaSalle was

358Paloian, 619 F.3d at 690. The Seventh Circuit remanded to the bank-

ruptcy court the question of whether MMA was bankruptcy remote. Id. at 695–96. On remand, the bankruptcy court denied the trustee's post-remand motionfor summary judgment in the adversary proceeding seeking to avoid prepetitionpayments as fraudulent transfers. See In re Doctors Hosp. of Hyde Park, Inc.,463 B.R. 93 (Bankr. N.D. Ill. 2011). The bankruptcy court considered the issuesof (a) whether MMA was actually separate from the debtor so that it was abankruptcy-remote entity and, if so, (b) whether the Hospital's sale of accountsreceivable to MMA was a true sale such that the Hospital's Chapter 11 trusteecould not recover payments made by MMA as fraudulent. It concluded thatthere were material issues of fact both as to the relevant entities operationalseparateness and whether the Hospital's sale of receivables was a true sale. 463B.R. at 113–14.

359Paloian, 619 F.3d at 690.

360Id.

361Id.

362Id. at 691.

363The Seventh Circuit in Paloian also discussed the practical advantage of

allowing the bankruptcy trustee to recover from the trustee to the securitizedpool who had direct access to the trust corpus, as opposed to seeking to recoverfrom potentially thousands of investors in trust certi�cates. Id. at 692.

364Bonded Financial Services, Inc. v. European American Bank, 838 F.2d

890, 17 Bankr. Ct. Dec. (CRR) 299, 18 Collier Bankr. Cas. 2d (MB) 155 (7th Cir.1988) (holding that the recipient of a transfer (a bank) was not a transferee forpurposes of § 550 of the Bankruptcy Code because it was an intermediary andhad no dominion over the transferred funds).


1108

the initial transferee because it was the legal owner of the trust'sassets.365

Arguably, the Seventh Circuit's determination in Paloian thatLaSalle was an initial transferee and not a mere conduit was un-duly results-oriented and overlooked several practicalities, includ-ing the possibility that LaSalle was a subsequent transferee.366

Similarly, the Eleventh Circuit in Harwell was not persuadedthat Hutton was a mere conduit simply acting as a �duciary wholacked discretion over the disbursement of the debtor's funds inhis client trust account (he was not the legal owner of the funds),given the allegations that Hutton was complicit in the fraudulenttransfer scheme that BJH conducted and carried out throughHutton's trust account. However, rather than adding a good faithrequirement as an element of the mere conduit defense, theEleventh Circuit might alternatively have found that Hutton hadmeaningful control over the funds because Hutton engineered thefraudulent transfer scheme, and therefore exercised some powerover how the funds would be disbursed, even if he was obligatedto transfer the settlement proceeds in accordance with BJH'sinstructions. Instead, the Eleventh Circuit determined that Hut-ton was an initial transferee because he was the �rst recipient ofthe fraudulent transfer and added a good faith requirement. Thisrequirement imposes an additional evidentiary hurdle in theEleventh Circuit for agents, banks, insurance brokers, and simi-lar parties who (a) are duty-bound to take only limited actionswith respect to funds owned by their clients and (b) seek to avoidliability under section 550(a) of the Bankruptcy Code as mereconduits.367

Although both the Eleventh and Seventh Circuits have bothrecently declined to �nd the mere conduit defense applicable inthe Harwell and Paloian cases, respectively, the remainingcircuits are not aligned, and a split on whether the mere conduitdefense requires proof of good faith by the defendant transferee

365Paloian, 619 F.3d at 691–92.

366The Seventh Circuit observed, however, that LaSalle Bank had not as-

serted it was a subsequent transferee entitled to rely upon section 550(b)'s a�r-mative defense. Id. at 692.

367See Perlman v. Wells Fargo Bank, N.A., 830 F. Supp. 2d 1308 (S.D. Fla.

2011) (holding that bank must demonstrate good faith to invoke mere conduitdefense in a Ponzi scheme fraudulent transfer action and relying on the Harwelldecision); In re Certi�ed HR Services Co., 2009 WL 2913244 (Bankr. S.D. Fla.2009) (holding that a �nding of good faith is required in order to invoke themere conduit defense and relying on In re Chase & Sanborn Corp., 848 F.2d1196, Bankr. L. Rep. (CCH) P 72363 (11th Cir. 1988)).


1109

may be developing. For example, similar to the Eleventh Circuit'sdecision in Harwell, the United States Court of Appeals for theFourth Circuit in In re Harbour368 has held that the mere conduitdefense is an equitable exception to initial transferee liabilityand one that inherently requires good faith on the part of thetransferee.369 However, the Seventh Circuit in Bonded Finan-cial,370 and the Second Circuit in Finley, Kumble371 each declinedto impose a good faith requirement for the “mere conduit” defenseto liability under section 550(a)(1) of the Bankruptcy Code, andhave found that mere conduits are not initial transferees.372

As discussed below, recent bankruptcy court decisions indicatethat bankruptcy courts are applying a more straightforward anal-ysis of the “mere conduit” test.

i. In re Brooke Corp.—Lead Bank for Note ParticipationIs a Mere Conduit

In a much-anticipated decision regarding a case of �rst impres-sion, in In re Brooke Corp., the United States Bankruptcy Courtfor the District of Kansas considered the issue of whether “[f]orpurposes of § 550(a) . . . a lead bank holding a note of the debtor[is] an initial transferee or a conduit when it receives allegedlypreferential payments from the debtor and, in accord with theparticipation agreement, immediately forwards the payments to

368In re Harbour, 845 F.2d 1254, 1258, 18 Collier Bankr. Cas. 2d (MB) 1214,

Bankr. L. Rep. (CCH) P 72308, 92 A.L.R. Fed. 621 (4th Cir. 1988). The districtcourt decision in In re Harwell discussed and distinguished In re Harbour. See414 B.R. at 775–76.

369See also 5 Collier on Bankruptcy at ¶ 540.550.02[4][b] (Alan N. Resnick &

Henry J. Sommer eds., 16th ed. 2012).370

Bonded Financial Services, Inc. v. European American Bank, 838 F.2d890, 17 Bankr. Ct. Dec. (CRR) 299, 18 Collier Bankr. Cas. 2d (MB) 155 (7th Cir.1988) (bank who took check payable to bank's order with note directing bank todeposit check into account of a�liate of transferor was an intermediary and notan initial transferee, but was a subsequent transferee who took it in good faithand for value and without knowledge of the voidability of the transfer).

371In re Finley, Kumble, Wagner, Heine, Underberg, Manley, Myerson &

Casey, 130 F.3d 52, 31 Bankr. Ct. Dec. (CRR) 978, 38 Collier Bankr. Cas. 2d(MB) 1851, Bankr. L. Rep. (CCH) P 77560 (2d Cir. 1997) (despite insurancebroker's participation in law �rm's insurance selection, following that decision,the insurance broker was a mere conduit for premiums transferred from debtorto insurer).

372Id. at 57–58; Bonded Financial, 838 F.2d at 894–95 (rejecting approach

that the court may use its equitable powers under § 550(a) to expand “initialtransferees” to include “anyone who touches the money” and �nding that aninitial transferee must have dominion over the subject of the transfer and theright to put the money to one's own purposes).


1110

the participants.”373 The bankruptcy court granted the lead bank'smotion for partial summary judgment and held that the leadbank to the loan participation was a mere conduit for purposes ofsection 550(a)(i) and not the initial transferee with respect tofunds it transmitted to participants who had purchased theirinterests in the debtor's note. As a result, the debtor could not re-cover such payments from the lead bank if such payments werefound to be preferential.374

In holding that the lead bank for the loan participation was amere conduit, the bankruptcy court in Brooke employed theSeventh Circuit's control test under Bonded Financial whenobserving that the lead bank had an unequivocal legal duty pur-suant to the participation agreements to distribute funds to theother participants within 10 days of receipt. The lead bank “couldnot, without breach of the Agreements and its legal obligations to[the other participants], use the funds for its own purposes.”375

The bankruptcy court in Brooke further noted that �nding thatthe lead bank “was a conduit, not an initial transferee, facilitatesthe Trustee's recovery of money from the [other participants], thereal recipients of allegedly preferential transfers.”376 The bank-ruptcy court in Brooke speci�cally distinguished the SeventhCircuit's holding in Paloian because, in Paloian, LaSalle Bank,as trustee to the securitized investment pool, was the legal ownerof the trust's assets and could draw money from the trust corpusfor any liability for avoided transfers. In Brooke, the lead bank ofthe loan participation was not the trustee and the loan partici-pants, not the lead bank, were the legal owners of their interestsin the note issued by the debtor.377

ii. In re Bower Adopts the “Control Test”In an decision not easily reconcilable with the result in Paloian,

the United States Bankruptcy Court for the District of Mas-sachusetts in In re Bower378 recently relied upon Bonded Finan-cial's “dominion and control test” to hold that a defendant/

373In re Brooke Corp., 458 B.R. 579, 585, 55 Bankr. Ct. Dec. (CRR) 154

(Bankr. D. Kan. 2011) (“Brooke”).374

Id. at 591.375

Id. at 587 (citing Bonded Financial, 838 F.2d at 893).376

Id.377

Id. at 590–91.378

In re Bower, 462 B.R. 347, Bankr. L. Rep. (CCH) P 82143 (Bankr. D.Mass. 2012).


1111

nominee379 of a mortgage noteholder who held legal title to themortgage at issue was a “mere conduit,” and not an initialtransferee, for purposes of recovery under section 550(a) of theBankruptcy Code.380 The bankruptcy court found that, althoughthe nominee held legal title and had the right to foreclose underMassachusetts law, pursuant to the terms of the mortgage instru-ment and the rules governing the nominee's relationship with theholder of the mortgage note, the nominee was an agent wholacked authority to act without direction from the noteholder orservicer. As such, the nominee was a mere conduit and not liablefor recovery under section 550(a).381

iii. In re Lambertson Truex, LLC Adopts the “ControlTest”

In a recent decision from the Bankruptcy Court for the Districtof Delaware, In re Lambertson Truex, LLC,382 the court followedthe “control” test advanced by the Seventh Circuit in BondedFinancial. In Lambertson Truex, the bankruptcy trustee soughtto recover an unauthorized postpetition payment to a law �rmengaged by the debtor to register the debtor's trademark.383 Thedefendant �rm outsourced the vast majority of the work to asecond �rm, and argued that the portion of the transfer attribut-able to the second �rm was protected by the mere conduitdefense.384 The court held that, because the defendant �rm hadalready paid the second �rm's invoice prior to receipt of thetransfer from the debtor, the defendant �rm had control over thefunds and was not obligated to funnel the funds directly to thesecond law �rm. Accordingly, the defendant was not deemed tobe a “mere conduit.”385

379The nominee was Mortgage Electronic Registration Systems, Inc., often

referred to as “MERS.” Id. at 348. As nominee, MERS held legal title to themortgage, which allowed the underlying note to be freely transferred. Id. at353.

380The mortgage was previously ordered avoided by the bankruptcy court

pursuant to section 544(a)(3) because the debtor's name was omitted from themortgage acknowledgement—a material defect. Id. at 350.

381Id. at 353–54.

382In re Lambertson Truex, LLC, 458 B.R. 155, 55 Bankr. Ct. Dec. (CRR)

148 (Bankr. D. Del. 2011).383

Id. at 157.384

Id. at 159.385

Id. at 159–160.


1112

2. In re Nieves: “Good Faith” and “Without Knowledge” forthe Section 550(b) Safe HarborThe Eleventh Circuit Court of Appeals is not the only court of

appeals to recently examine the standards for analyzing the “goodfaith” requirement for avoiding liability under section 550 of theBankruptcy Code. In Nieves,386 the Fourth Circuit Court of Ap-peals also examined the requirements of good faith, albeit withrespect to a defendant relying on the a�rmative defense forsubsequent transferees provided in section 550(b) of the Bank-ruptcy Code.

As discussed above, section 550(b) of the Bankruptcy Codecontains a safe harbor that protects recipients of alleged fraudu-lent transfers who are not initial transferees or the entities forwhose bene�t such transfers were made from liability for recoveryfrom an avoidance action brought under, among other sections,sections 544 and 548 of the Bankruptcy Code. Speci�cally, sec-tion 550(b)(1) provides that a subsequent transferee will beprotected from liability if the subsequent transferee took (i) forvalue, (ii) in good faith, and (iii) without knowledge of the void-ability of the transfer.387 All three prongs of section 550(b)(1)must be satis�ed in order to rely on the safe harbor.388 However,since the Bankruptcy Code does not de�ne good faith, courtshave grappled over the de�nition of good faith, as is apparentfrom discussions throughout this article.389 The Fourth CircuitCourt of Appeals, in a case of �rst impression in that circuit,examined this issue in Nieves and concluded that (a) for purposesof section 550(b) of the Bankruptcy Code good faith is determinedby an objective standard and (b) a subsequent transferee who

386In re Nieves, 648 F.3d 232, 242, 65 Collier Bankr. Cas. 2d (MB) 1442,

Bankr. L. Rep. (CCH) P 82024 (4th Cir. 2011) (“Nieves”).387

See id.; 11 U.S.C. § 550(b)(1).388

11 U.S.C. § 550(b)(1); Nieves, 648 F.3d at 242.389

In fact, the de�nition of “good faith” is widely variable. A number ofcourts have held that good faith de�es precise de�nition and, as a result, mustbe determined on a case-by-case basis. See, e.g., In re Roco Corp., 701 F.2d 978,984, 10 Bankr. Ct. Dec. (CRR) 275, 8 Collier Bankr. Cas. 2d (MB) 457, Bankr.L. Rep. (CCH) P 69088 (1st Cir. 1983) (good faith, with respect to § 548(c), is notsusceptible to precise de�nition); In re Grove-Merritt, 406 B.R. 778, 810 (Bankr.S.D. Ohio 2009) (good faith should be determined on case-by-case basis); In reWorld Vision Entertainment, Inc., 275 B.R. 641, 659 (Bankr. M.D. Fla. 2002)(good faith de�es precise de�nition); In re Kanterman, 97 B.R. 768, 779 (Bankr.S.D. N.Y. 1989), a�'d, 108 B.R. 432 (S.D. N.Y. 1989) (good faith should bede�ned on a case-by-case basis).


1113

“willfully turned a blind eye to a suspicious transaction” did notsatisfy the good faith prong of section 550(b).390

The Fourth Circuit in Nieves also examined the standard ap-plicable to the “without knowledge” requirement of section 550(b),as well as whether mediate or immediate (i.e. subsequent)transferees are subject to a di�erent standard than initialtransferees under the good faith prong of section 550(b).391 Indeciding these issues, the Fourth Circuit a�rmed the rulings ofboth lower courts on the issue of good faith.392 It held that forpurposes of section 550(b), “without knowledge” means that a de-fendant does not have actual knowledge of facts that would leada reasonable person to believe that a transfer was voidable, thatgood faith should be determined under an objective standard,393

and that the good faith standard applicable to subsequenttransferees is the same as that required for initial transferees.

In Nieves, Walter Nieves (“Nieves”), shortly before �ling forprotection under Chapter 13 of the Bankruptcy Code, transferred

390Nieves, 648 F.3d at 242.

391In this instance, Capital City Mortgage Corporation was a mediate

transferee of the Initial Transferee (as de�ned below). See In re Nieves, 2007WL 2915004, *4 (Bankr. D. Md. 2007), order a�'d, 2008 WL 3989144 (D. Md.2008), a�'d, 648 F.3d 232, 65 Collier Bankr. Cas. 2d (MB) 1442, Bankr. L. Rep.(CCH) P 82024 (4th Cir. 2011).

392Nieves, 648 F.3d at 241–42; see also In re Nieves, 2008 WL 3989144 (D.

Md. 2008), a�'d, 648 F.3d 232, 65 Collier Bankr. Cas. 2d (MB) 1442, Bankr. L.Rep. (CCH) P 82024 (4th Cir. 2011).

393The Fourth Circuit noted that its decision was consistent with a number

of similar decisions from courts in other circuits holding that good faith isdetermined by an objective standard. Nieves, 648 F.3d at 238–39, 241; see, e.g.,In re Sherman, 67 F.3d 1348, 1355, 27 Bankr. Ct. Dec. (CRR) 1237, 34 CollierBankr. Cas. 2d (MB) 655, Bankr. L. Rep. (CCH) P 76671 (8th Cir. 1995); In reAgricultural Research and Technology Group, Inc., 916 F.2d 528, 535–36, 23Collier Bankr. Cas. 2d (MB) 1517, Bankr. L. Rep. (CCH) P 73652 (9th Cir.1990); Bonded Financial, 838 F.2d at 897–98 (applying an objective standard of“good faith” to a subsequent transferee for purposes of § 550(b)); In re Laines,352 B.R. 397, 406 (Bankr. E.D. Va. 2005) (citing Brown, 67 F.3d at 1355) (stat-ing similarly); see also, In re Enron Corp., 340 B.R. 180, 208, 46 Bankr. Ct. Dec.(CRR) 71 (Bankr. S.D. N.Y. 2006) (citing In re M & L Business Mach. Co., Inc.,84 F.3d 1330, 1338, 29 Bankr. Ct. Dec. (CRR) 188, 36 Collier Bankr. Cas. 2d(MB) 996 (10th Cir. 1996)) (utilizing an objective standard in de�ning “goodfaith”). But see In re Teleservices Group, Inc., 444 B.R. 767, 815 (Bankr. W.D.Mich. 2011) (applying a subjective approach that considers the actual knowl-edge of the transferee at the time of the transfer). The Fourth Circuit, however,is one of the few circuits that has imposed a “good faith” requirement for initialtransferee exemption from liability. See section III.C.1. of this article.


1114

a parcel of land for no consideration.394 Approximately eightmonths later, the initial transferee transferred the land to 1stFinancial Mortgage Services LLC (“1st Financial”) for allegedconsideration of $18,000.395 Sixteen days before the land wastransferred to 1st Financial, Michael Nastasi (“Nastasi”), a friendof Nieves and the owner of 1st Financial, approached CapitalCity Mortgage Corporation (“CCM”) and applied for a loan onbehalf of 1st Financial, with such loan to be secured by the land.396

In deciding whether to lend to 1st Financial, CCM did not utilizestandard industry processes for approval of the loan.397 Speci�-cally CCM did not attempt to: (i) verify 1st Financial's corporategood standing certi�cation,398 (ii) verify whether Nastasi was anauthorized signatory of 1st Financial; (iii) obtain any �nancial in-formation regarding 1st Financial; (iv) verify the validity of 1stFinancial's deed to the land; or (v) perform a title search with re-spect to the land.399 Nonetheless, CCM made a loan in the amountof $155,000 to 1st Financial, which loan was secured by theland.400 After issuance of the loan, the Chapter 13 case wasdismissed and Nieves subsequently �led a Chapter 7 petition.401

1st Financial never made any payments on the loan from CCMand CCM later asserted a right to the proceeds of any sale of theland in the Chapter 7 case.402

The Chapter 7 trustee (the “Trustee”) overseeing the case �ledadversary proceedings against the initial transferee, 1st Financialand CCM403 seeking to avoid and recover all of the transfers re-

394Nieves, 648 F.3d at 235–36.

395Id.

396Id.

397Id. at 241–42.

398In fact, at the time of the initial meeting between Nastasi and CCM, as

well as when the land was transferred, 1st Financial was not a valid businessentity. Id. at 236.

399Id. at 234–36.

400Id. at 234.

401Id. at 236.

402Id. at 234–36. The land was sold for $475,000 in the Debtor's Chapter 7

case; see also In re Nieves, 2007 WL 2915004, *3–4 (Bankr. D. Md. 2007), ordera�'d, 2008 WL 3989144 (D. Md. 2008), a�'d, 648 F.3d 232, 65 Collier Bankr.Cas. 2d (MB) 1442, Bankr. L. Rep. (CCH) P 82024 (4th Cir. 2011).

403Nieves, 648 F.3d at 235–36.


1115

lating to the land pursuant to sections 544404 and 550 of the Bank-ruptcy Code.405 Although the transfers to the initial transfereeand 1st Financial were avoided consensually, CCM challengedthe avoidability of the transfer of the land from 1st Financial toCCM. Following a trial, the bankruptcy court ruled in favor ofthe Trustee, avoided the transfer to CCM and ordered that theTrustee could recover from the proceeds of the sale of the land,�nding that CCM was not entitled to protection under section550(b) because it did not take in good faith and without knowl-edge of the voidability of the transfer.406 The district courta�rmed.407 On appeal to the Fourth Circuit, CCM argued thatboth lower courts had applied an incorrect standards for goodfaith and knowledge when analyzing the a�rmative defenseprovided by section 550(b) of the Bankruptcy Code.408

a. Determining a Transferee's Knowledge for thePurpose of Section 550

In deciding whether the lower courts had applied the correctstandards for analyzing eligibility to rely on the a�rmativedefense provided by section 550(b) of the Bankruptcy Code, theFourth Circuit �rst acknowledged that the Bankruptcy Codeprovides no de�nition as to “what it means to take ‘in good faith’or ‘without knowledge of the voidability of the transferavoided.’ ”409 The Fourth Circuit noted that it had only once beforeexamined section 550(b) of the Bankruptcy Code, in Smith v.Mixon, when it addressed the issue of what constitutes knowl-edge for the purposes of section 550(b)(1) of the Bankruptcy

404Section 544 allows a trustee to “avoid any transfer of an interest of the

debtor in property . . . that is voidable under applicable law by a creditor hold-ing an unsecured claim.” 11 U.S.C. § 544(b).

405Nieves, 648 F.3d at 235–36.

406Id. at 236; see also In re Nieves, 2007 WL 2915004, *7–8 (Bankr. D. Md.

2007), order a�'d, 2008 WL 3989144 (D. Md. 2008), a�'d, 648 F.3d 232, 65Collier Bankr. Cas. 2d (MB) 1442, Bankr. L. Rep. (CCH) P 82024 (4th Cir.2011).

407Nieves, 648 F.3d at 236; see also In re Nieves, 2008 WL 3989144, *3–4 (D.

Md. 2008), a�'d, 648 F.3d 232, 65 Collier Bankr. Cas. 2d (MB) 1442, Bankr. L.Rep. (CCH) P 82024 (4th Cir. 2011).

408Nieves, 648 F.3d at 237–39.

409Id. at 237.


1116

Code.410 In Smith v. Mixon, the Fourth Circuit held that knowl-edge for purposes of section 550(b)(1) of the Bankruptcy Code didnot mean constructive notice, but rather meant actual notice.411

The bankruptcy court's application of Mixon’s actual noticestandard was the primary basis for CCM's appeal. Speci�cally,CCM argued that the bankruptcy court erred in holding thatMixon did not limit knowledge to facts of which a defendant wascognitive, arguing that its application was too broad.412 TheFourth Circuit disagreed with the bankruptcy court's conclusionthat CCM took the land with knowledge of the voidability of thetransfer, and, in fact, the Fourth Circuit recognized that CCMdid not have actual knowledge of facts that would lead a reason-able person to believe that the transfer was voidable. The FourthCircuit, however, agreed with the bankruptcy court's reading ofMixon, to the extent that, in determining CCM's knowledge, itheld CCM to a constructive or inquiry notice standard, regardlessof what CCM actually knew about the transfer.413

In addition, the Fourth Circuit clari�ed its holding in Mixon,noting that it went beyond stating merely that knowledge, for thepurposes of section 550(b)(1) of the Bankruptcy Code, is limitedto actual notice.414 The Fourth Circuit explained that Mixon’sstandard means that when no available facts suggest the exis-tence of a potentially fraudulent transfer, there is no duty toinvestigate or be a watchdog for a creditor's bene�t.415 The FourthCircuit further explained that where a transferee knew of factsthat would lead a reasonable person to believe that the trans-ferred property was recoverable, such a transferee would be held

410Id. (citing Smith v. Mixon, 788 F.2d 229, 232, 14 Bankr. Ct. Dec. (CRR)

688, 14 Collier Bankr. Cas. 2d (MB) 704, Bankr. L. Rep. (CCH) P 71080 (4thCir. 1986)).

411Mixon involved a situation where the transferees of a parcel of property,

which was encumbered by a fraudulent deed of trust, sought protection from abankruptcy trustee's avoidance action with respect to the transfer of the prop-erty. Mixon, 788 F.2d at 230–31. While the district court allowed the bank-ruptcy trustee to avoid the transaction, the Fourth Circuit reversed the districtcourt and held that the transferee had taken the property in “good faith” andfor value and, thus, the transfer was not subject to avoidance. Id. at 231–32.

412Nieves, 648 F.3d at 237.

413Id. at 241.

414Id. at 237–38 (citing Mixon, 788 F.2d at 232).

415Id. at 238 (citing In re Bressman, 327 F.3d 229, 237, 41 Bankr. Ct. Dec.

(CRR) 74, Bankr. L. Rep. (CCH) P 78837, 16 A.L.R. Fed. 2d 801 (3d Cir. 2003)).


1117

to have knowledge.416 The Fourth Circuit expounded that Mixon’sactual notice standard does not require actual knowledge of thetransfer's voidability but, rather, in order to satisfy the actual no-tice standard, a transferee is required to have actual knowledgeof facts that would lead a reasonable person to believe that thetransferred property was voidable.417 In so holding, the FourthCircuit rejected CCM's argument that all that was required for a�nding of good faith was an absence of actual knowledge.418

b. The Objective “Good Faith” Standard Under Section550(b)

The Fourth Circuit next tackled the issue of whether the bank-ruptcy and district courts had applied the correct standard fordetermining good faith.419 Those courts applied an objective stan-dard in conducting their analysis of section 550(b).420 The Fourth

416Id. (citing In re Nordic Village, Inc., 915 F.2d 1049, 1055, 21 Bankr. Ct.

Dec. (CRR) 1335, 23 Collier Bankr. Cas. 2d (MB) 1491, Bankr. L. Rep. (CCH) P73650, 91-1 U.S. Tax Cas. (CCH) P 50028, 66 A.F.T.R.2d 90-5652 (6th Cir.1990)) (quoting Mixon, 788 F.2d at 232 n.2).

417Id. (emphasis added). This standard was recently adopted by the United

States Bankruptcy Court for the District of Massachusetts in In re Bower,where the court found that the assignee of an avoided mortgage (BNYMellon), asuccessor trustee to a securitized pool of mortgages who undoubted took forvalue, was not exempt from liability under section 550(b) of the BankruptcyCode because a defect on the face of the mortgage rendered incredible BNYMel-lon's argument that it lacked knowledge of facts suggesting that the underlyingtransfer was avoidable which should have compelled it to investigate. In reBower, 462 B.R. 347, 354–56, Bankr. L. Rep. (CCH) P 82143 (Bankr. D. Mass.2012). As a point of note, in Paloian, LaSalle Bank did not argue it was asubsequent transferee who was exempt from liability as a good faith transfereepursuant to section 550(b) of the Bankruptcy Code. See Paloian, 619 F.3d. at691. The Seventh Circuit, did, however, observe that the trust's investors werepersons “for whose bene�t” the transfers were made, which would similarlyrender them unable to rely on section 550(b). Id. at 692.

418Nieves, 648 F.3d at 240.

419Id. at 238–42. In doing so, the Fourth Circuit noted that the Bankruptcy

Code is not helpful in de�ning “good faith.”420

The United States Court for the District of Maryland reached its de�ni-tion of good faith by relying on a number of cases both within and outside of theFourth Circuit, and held that good faith exists when a transferee lacks knowl-edge of circumstances that would cause a reasonable person to investigate. In reNieves, 2007 WL 2915004, *5 (Bankr. D. Md. 2007), order a�'d, 2008 WL3989144 (D. Md. 2008), a�'d, 648 F.3d 232, 65 Collier Bankr. Cas. 2d (MB)1442, Bankr. L. Rep. (CCH) P 82024 (4th Cir. 2011). The bankruptcy court heldthat an inquiry into good faith is not limited to actual knowledge from a subjec-tive viewpoint, rather it should be based on an objective standard. Id. TheDistrict Court for the District of Maryland, in a�rming, relied on Mixon and


1118

Circuit noted that the determination of the good faith standardunder section 550(b) was an issue of �rst impression in the FourthCircuit.421 It found that both lower courts correctly held that goodfaith, for the purpose of section 550(b)(1) of the Bankruptcy Code,should be determined using an objective standard.422 The FourthCircuit further noted that in de�ning good faith, a court shouldanalyze what the transferee knew or should have known, insteadof examining the transferee's actual knowledge from a subjectiveposition,423 and observed that what a transferee “should haveknown” depends upon what the transferee actually knew, andnot what the transferee was deemed to have known.424 Thus, theFourth Circuit concluded that if a transferee has knowledge suf-�cient to put him on inquiry notice of a debtor's possibleinsolvency, this knowledge would be enough to put the transferat issue beyond the reach of section 550(b)'s good faith defense.425

Turning to the situation at hand, the Fourth Circuit found thatCCM could not have taken the land in good faith because CCMwillfully ignored facts that typically would have lead a lender,such as CCM, to inquire as to the background of the transfer andthat cried out for investigation.426 In doing so, the Fourth Circuitheld that the bankruptcy court applied the correct legal standard

other decisions from within the Fourth Circuit to reach the conclusion that thecorrect standard of “good faith” is an objective standard, and that just because atransferee lacks actual knowledge does not necessarily mean that suchtransferee has taken the land in good faith. In re Nieves, 2008 WL 3989144, *3(D. Md. 2008), a�'d, 648 F.3d 232, 65 Collier Bankr. Cas. 2d (MB) 1442, Bankr.L. Rep. (CCH) P 82024 (4th Cir. 2011).

421Nieves, 648 F.3d at 237.

422Id. at 238, 242.

423Id. at 239–40 (citing In re Laines, 352 B.R. 397, 406 (Bankr. E.D. Va.

2005)) (quoting In re Sherman, 67 F.3d 1348, 1355, 27 Bankr. Ct. Dec. (CRR)1237, 34 Collier Bankr. Cas. 2d (MB) 655, Bankr. L. Rep. (CCH) P 76671 (8thCir. 1995)).

424Id. at 239–40.

425Id.

426Id. at 241–42 (emphasis added). These circumstances included: (i) confu-

sion over the actual legal name of 1st Financial; (ii) CCM's reliance on a month-old certi�cate of good standing; and (iii) CCM's inadequate title search todetermine if 1st Financial was the true owner of the land. Id. Recently theSouthern District of New York articulated a similar standard for the good faithdefense under section 548(c) of the Bankruptcy Code which that court called“willful blindness.” See Picard v. Katz, 462 B.R. 447, 55 Bankr. Ct. Dec. (CRR)133, Bankr. L. Rep. (CCH) P 82077 (S.D. N.Y. 2011), motion to certify appealdenied, 466 B.R. 208, 55 Bankr. Ct. Dec. (CRR) 266 (S.D. N.Y. 2012); see alsosection III.B. of this article.


1119

of good faith and that it did not view as clearly erroneous thebankruptcy court's �nding that “facts known to CCM would havelead a ‘lender under the circumstances of this case [to] inquire asto the possible records.’ ”427 In adopting an objective good faithstandard for purposes of section 550(b), the Fourth Circuit reliedon its opinion in In re Harbour construing section 550(a) of theBankruptcy Code. In re Harbour holds that an initial transfereemust act in good faith as determined by an objective standard tobe entitled to rely upon the mere conduit exception to liability.428

While the Fourth Circuit endorsed an objective standard forgood faith, it clari�ed that good faith includes both an objectiveand subjective component.429 Under the subjective component ofgood faith a court will look to the “honesty” and “state of mind” ofthe transferee.430 Under the objective component a transfereedoes not act in good faith if it fails to abide by the typical routinebusiness practices of the industry in which it operates.431 Thus,the Fourth Circuit concluded that in determining good faith, acourt will look at what a “transferee knew or should have known”while also taking into account the “customary practices of theindustry in which the transferee operates.”432 Additionally, theFourth Circuit stated that its holding was consistent with thegood faith standard as it exists in other areas of commercial lawand speci�cally in the Uniform Commercial Code.433

As part of its good faith analysis, the Fourth Circuit considered

427Nieves, 648 F.3d at 241.

428Id. at 239 (citing In re Harbour, 845 F.2d 1254, 18 Collier Bankr. Cas. 2d

(MB) 1214, Bankr. L. Rep. (CCH) P 72308, 92 A.L.R. Fed. 621 (4th Cir. 1988)).The Fourth Circuit also stated that other circuit courts have held similarly withrespect to § 550(b). Nieves, 648 F.3d. at 238–39. See In re Sherman, 67 F.3d1348, 27 Bankr. Ct. Dec. (CRR) 1237, 34 Collier Bankr. Cas. 2d (MB) 655,Bankr. L. Rep. (CCH) P 76671 (8th Cir. 1995); In re Agricultural Research andTechnology Group, Inc., 916 F.2d 528, 23 Collier Bankr. Cas. 2d (MB) 1517,Bankr. L. Rep. (CCH) P 73652 (9th Cir. 1990); Bonded Financial, 838 F.2d at890. However, as noted in section III.C.1. of this article, the imposition of a“good faith” requirement to the “mere conduit” defense is somewhatcontroversial.

429Nieves, 648 F.3d at 239.

430Id. (citing Tri�n v. Pomerantz Sta�ng Services, LLC, 370 N.J. Super.

301, 851 A.2d 100, 104, 53 U.C.C. Rep. Serv. 2d 927 (App. Div. 2004)).431

Id. (citing Rudiger Charolais Ranches v. Van De Graaf Ranches, 994 F.2d670, 672–73, 20 U.C.C. Rep. Serv. 2d 912 (9th Cir. 1993)).

432Id. at 240.

433Id. at 239 (noting that both U.C.C. § 3-302 and § 1-304 apply similar

standards of good faith).


1120

whether a subsequent transferee is subject to the same standardof good faith as an initial transferee who seeks exemption from li-ability as a mere conduit. The Fourth Circuit again looked toHarbour, stating that its ruling in that case was instructive anddetermined that an objective standard of good faith will apply toall types of transferees and that an entity or person that wishesto be seen as taking in good faith cannot be willfully ignorant inthe face of facts which “cry out for investigation.”434

c. ConclusionThe Nieves decision bolsters a shift towards an objective inter-

pretation of the good faith requirement for the applicability ofthe safe harbor from avoidable transfers under section 550 of theBankruptcy Code.435 In addition, as a result of Nieves, at least inthe Fourth Circuit, initial and subsequent transferees are allsubject to the same good faith standard when it comes to section550 of the Bankruptcy Code.

IV. SUMMARYThe recent decisions discussed above are likely the harbingers

of a number of trends. While lenders had a short respite follow-ing TOUSA II, heightened diligence requirements for lenderswho are receiving repayment of antecedent debt have beenreinstated following the Eleventh Circuit's recent reversal inTOUSA III of the district court's determinations (a) that indirectand intangible bene�ts (including the opportunity to avoid an im-mediate bankruptcy) can be considered reasonably equivalentvalue and (b) that lenders who are repaid during the period lead-ing up to a transferor's bankruptcy would be considered subse-quent transferees for purposes of section 550 of the BankruptcyCode and not parties for whose bene�t the liens securing a newloan were granted. With its decisions in TOUSA III and Harwell,the Eleventh Circuit has perhaps established its preference forinterpretations of section 550 of the Bankruptcy Code that facili-tate recovery for avoidable transfers. In addition, the decisionsdiscussed indicate that the a�rmative defense provided by sec-

434Id. (citing In re Harbour, 845 F.2d at 1258).

435Recently the Untied States Bankruptcy Court for the Southern District of

New York cited Nieves when tackling the question of what is the proper stan-dard for good faith under section 548(c) of the Bankruptcy Code. See In reDreier LLP, 452 B.R. 391, 447–48 (Bankr. S.D. N.Y. 2011). Although noting thatthe determination of the proper legal standard for “good faith” under section548(c) would have to wait for further developments in the case, the court notedthat Nieves joined most courts in adopting an objective standard, albeit with re-spect to section 550(b). Id.


1121

tion 548(c) will continue to be the subject of dispute, making itchallenging for plainti�s to succeed in dispositive motions whenthe good faith defense is asserted, particularly if more courtsadopt a standard requiring a showing of the transferee's willfulignorance of facts relating to the fraudulent nature of the transferin order to defeat the defense. Similarly, the a�rmative defensecontained in section 550(b) also will likely be the subject of fur-ther dispute due to uncertainty about the applicable standardsfor knowledge and good faith, as well as the factual context inwhich it is raised. The mere conduit theory for avoidance of initialtransferee liability will inevitably be the topic of future decisions,not only because of its highly factual nature, but also because ofthe apparent divide between the circuits on the issues of whethera mere conduit is an initial transferee and whether a mereconduit must demonstrate its good faith when receiving a fraudu-lent transfer. The applicability of the section 546(e) safe harborin actions seeking avoidance of constructively fraudulenttransfers remains controversial and can involve high stakes, asdemonstrated in the decisions in avoidance actions commenced inthe BLMIS liquidation proceedings.

The cases discussed also provide warnings for both trustees ofsecuritized investment pools and attorneys who allow distressedparties to make transfers through their trust accounts. Attorneysmay not simply hide behind their �duciary role when acceptingand distributing funds from their trust accounts. Trustees ofsecuritized pools of assets should be aware of their potentialfraudulent transfer liability as initial transferees under section550(a) of the Bankruptcy Code (and reminded to assert theirstatus as subsequent transferees when possible), but it appearsthat entities acting solely as agents to �nancing facilities may beable to successfully invoke the mere conduit defense to initialtransferee liability.


1122

sections 548 and 550 recent developments in the law … · in the law of fraudulent transfers and...

Documents